Summary

In order for a taxable person to be deprived of the right to deduct input tax it had to be shown that he knew or should have known that his transaction was connected with fraudulent evasion of VAT, and it was not sufficient to show that he knew or should have known that it was more likely than not that his transaction was so connected. However, a trader could be regarded as a participant and lose his right to deduct where he should have known that the only reasonable explanation for the circumstances in which a transaction took place was that it was connected with VAT fraud.

Facts

The appellants in three cases appealed against decisions concerning the Revenue and Customs Commissioners' refusal of input tax credit claims on the grounds of VAT fraud. In the first appeal, the commissioners denied the repayment claims of the trader (M). It was accepted that every one of the chains of transactions which had been traced led back to a defaulter. M had been warned that its transactions were more likely than not to be connected with fraud. The tribunal and judge concluded that M should have known that all its transactions were leading back to defaulting traders. The issue in M's appeal was whether the commissioners were entitled to refuse repayment in circumstances where the trader ought to have known that it was more likely than not that his transactions would be implicated in missing trader fraud. The second appeal concerned what was called "contra-trading". In contra-trading there were two chains, a "clean" and a "dirty" chain. The effect of the clean chain was to remove the necessity of a trader taking part in the dirty chain making a repayment claim. The tribunal held that the trader (B) ought to have known that it was participating in transactions connected with VAT fraud. The judge allowed an appeal on the basis that it was necessary in such a case to prove that the contra trader was party to a conspiracy, since otherwise it was impossible to establish that B had known of any fraud. The issue on the commissioners' appeal was thus the extent of the knowledge which it had to be established that B had or ought to have had. In the third appeal the tribunal found that the traders (C) and the individual who controlled them were well aware that the transactions were fraudulent and the judge held that the tribunal was entitled to make a finding of actual knowledge.

Held

(1) The right to deduct was fundamental to the system of VAT because it ensured that the charge was limited to the value added at each stage of the supply and because it ensured fiscal neutrality. Objective criteria determined both the scope of the tax and the circumstances in which the right to deduct arose. Where a person committed fraud he would not be able to establish that those objective criteria had been met; conversely the objective criteria were met where a taxable person did not know or have any means of knowing that the transaction was connected with fraud, Optigen Ltd v Customs and Excise Commissioners (C-354/03) (2006) Ch 218 ECJ (3rd Chamber) considered. (2) The principle, that the objective criteria were not met where tax was evaded, had been extended beyond evasion by the taxable person himself to the position of those who knew or should have known that they were taking part in a transaction connected with fraudulent evasion of VAT, Kittel v Belgium (C-439/04) (2008) STC 1537 ECJ (3rd Chamber) followed. (3) The principles in Kittel did not depend on the enactment of any specific legislation in the United Kingdom. (4) The phrase "knew or should have known" in Kittel had the same meaning as the phrase "knowing or having any means of knowing" in Optigen. If a taxpayer had the means at his disposal of knowing that by his purchase he was participating in a transaction connected with fraudulent evasion of VAT he lost his right to deduct. It did not matter that in domestic law fraud denoted a more culpable state of mind. (5) Kittel covered the case where it had been shown that the trader knew or should have known that the transaction was connected to fraud and did not extend to circumstances in which a trader should have known that it was more likely than not that the transaction was connected with fraud. However, a trader could be regarded as a participant within Kittel 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 fraud. Tribunals should not unduly focus on the question of due diligence. The fact that a trader had asked appropriate questions, did not entitle him to ignore the circumstances in which his transactions took place. (6) Such an approach did not infringe the principle of legal certainty. That principle provided no warrant for restricting the connection which had to be established to a fraudulent evasion which immediately preceded a trader's purchase. (7) The principle in Kittel was compliant with the rights of traders to freedom from interference with their property enshrined in the European Convention on Human Rights 1950 Protocol 1 art.1 and no penalty was imposed. (8) In M's case the tribunal and judge applied the wrong test of connection, but if they had applied the right test they would have concluded that M should have known that its transactions were connected with fraud because that was the only reasonable explanation for the circumstances in which the transactions in question were undertaken. Therefore M's appeal was dismissed. (9) The commissioners' appeal in the case of B was dismissed. The tribunal's findings were insufficient to establish that B should have known that it was participating in transactions which were connected with fraud. (10) The findings of actual knowledge in the case of C could not be challenged and its appeal was dismissed.

Judgment accordingly