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1 BLUE SPHERE GLOBAL_ MOBILX _ CALLTEL 12th May 2010 By Don Mavin Powered By Docstoc
					                        BLUE SPHERE GLOBAL, MOBILX & CALLTEL

12th May 2010

By Don Mavin, Head of Tax Disputes & Litigation at Vantis, the UK accounting, tax
and business advisory and recovery group.

The Court of Appeal has today (12 May 2010) handed down its hotly anticipated decision in
the joined appeals of Blue Sphere Global Limited (“BSG”), Mobilx Limited (in Administration)
(Mobilx) and Calltel Telecom Limited and Opto Telelinks Limited (Calltel).

As many had hoped, their Lordships have distinguished the three cases and have considered
the facts of each case separately. The findings of the Court may simply be summarised thus:
Mobilx and Calltel have lost, and BSG has won. However, behind that over-simplified
assessment lies a judgement which will have wide-reaching repercussions for both traders
and the Commissioners of HM Revenue & Customs (HMRC) alike.

All three of the appeals were concerned with the nature and meaning of the legal test which
should be applied in deciding whether a trader should be deprived of the right to reclaim
input tax. Cases of this sort have, as time has gone by, been characterised simply as “MTIC
means of knowledge cases”, and it has been easy to lose sight of the original wording which
gave rise to this type of litigation. It is set out within the ECJ’s ruling in the Kittel case, and is
reproduced on the first page of Lord Justice Moses’ decision:

"it is ascertained, having regard to objective factors, that the taxable person knew or
should have known [emphasis added] that, by his purchase, he was participating in a
transaction connected with fraudulent evasion of VAT".

This so-called “Kittel principle” has been adapted and interpreted in a number of ways, and
as the case law has evolved, HMRC have retreated from the relatively clear meaning set out
within the emphasised passage above, and have put up alternative arguments – for example,
that a trader ought to have known that its transactions were connected to fraud simply
because fraud is prevalent, or knowledge that a transaction is more likely than not to have
been connected to fraud.

It was fortuitous that the three cases all, to some degree or other, typified a particular level
or type of knowledge as cited by HMRC in support of their decision to deny VAT repayment

Calltel was described in the decision as:

“…a paradigm of a case where the traders knew of the connection between the transactions
in which they were involved and VAT fraud”.

The Court of Appeal has not seen fit to disturb the findings of either the original VAT Tribunal
or the High Court, and has – as many had expected – found that in such circumstances
HMRC were perfectly entitled to deny repayment of the traders’ input tax claims.

Matters were less clear cut in the other two cases – Mobilx and BSG.

In the case of Mobilx, the argument to be considered by the Court was whether HMRC is
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 MTIC fraud.

It was pointed out by the Mobilx Tribunal that the directors of the company had failed to take
proper account of the warnings they had received from HMRC that their transactions were
tainted by VAT fraud. It followed, therefore, that the risks inherent in their mode of trading
had been pointed out to them.

However, the Court of Appeal stops short of accepting that mere awareness of a risk is
sufficient to justify the denial of a VAT repayment claim, and Lord Justice Moses states, at
paragraph 55:

If HMRC was right and it was sufficient to show that the trader should have known that he
was running a risk that his purchase was connected with fraud, the principle of legal certainty
would, in my view, be infringed. A trader who knows or could have known no more than that
there was a risk of fraud will find it difficult to gauge the extent of the risk; nor will he be able
to foresee whether the circumstances are such that it will be asserted against him that the
risk of fraud was so great that he should not have entered into the transaction. In short, he
will not be in a position to know before he enters into the transaction that, if he does so, he
will not be entitled to deduct input VAT. The principle of legal certainty will be infringed.

The Court has, therefore, found that both the original Tribunal and Floyd J. in the High Court
applied the wrong legal test in reaching their respective decisions against Mobilx:

The question was not whether Mobilx should have known that its transactions were more
likely than not to be connected with fraud (the test applied by the Tribunal at § 108 and by
Floyd J at § 88). The correct question is whether it should have known that its transactions
were connected with fraud.

However, Lord Justice Moses finds that, in spite of this error, the finding that HMRC had been
fully entitled to deny Mobilx’s VAT repayments was correct. The Tribunal and the High Court
had heard that the company had consistently failed to act upon the numerous warnings given
by HMRC that the transactions in which Mobilx were engaged were tainted by fraud.

Although the mere existence of risk in a market is insufficient to justify a denial of VAT
repayment, if a trader persistently ignores that risk then he does so at his peril:

In my judgment, on the basis of those findings the true and only reasonable conclusion, is
that Mobilx ought to have known that the only realistic possibility, as it continued to trade in
that manner, was that its purchases would be connected with fraudulent evasion of VAT and
not merely that all its transactions were more likely than not to be connected with fraud. In
those circumstances, despite the Tribunal's error of law in the test which it applied, that error
makes no difference to the true and only reasonable conclusion.

BSG – a contra trading case – presented a different argument still – namely, that the
company ought to have known that there was a risk that the transactions in which it
participated were connected with the fraudulent evasion of VAT.

It was never alleged by HMRC that BSG had actual knowledge of the alleged fraud with which
its transactions were connected, and, indeed, the original Tribunal concluded thus:

"Our conclusion is that BSG ought to have known that, by its purchases, it was participating
in transactions connected with fraudulent evasion of VAT." [Emphasis added]

However, it was subsequently found by the Chancellor in the High Court that the Tribunal
erred in concentrating unduly upon the extent to which the company director had approached
his due diligence procedures, and the Court of Appeal upholds the Chancellor’s view that the
Tribunal had failed to establish that the evidence supported a finding that BSG ought to have
known that its transactions were connected to fraud.

Lord Justice Moses makes it clear, however, that had it not been for the Tribunal’s undue
focus on BSG’s due diligence, he may not have been so inclined to find in BSG’s favour. The
Tribunal had identified what it considered to be “un-commercial” features and circumstances
surrounding the BSG deals, but had examined these matters almost exclusively in the context
of BSG’s due diligence, setting out a series of questions which the company director should
have posed.

Lord Justice Moses finds:

The ultimate question is not whether the trader exercised due diligence but rather whether
he should have known that the only reasonable explanation for the circumstances in
which his transaction took place was that it was connected to fraudulent evasion
of VAT. [Emphasis added] The Tribunal might have concluded that Mr Peters should have
known that the transactions into which he entered were connected with fraud, by reference
to the unconventional nature of those circumstances (a finding it came close to making at §
228). But it was not the only decision within the bounds of reasonable conclusion.

This paragraph contains the crux of the Court of Appeal’s decision. The focus in MTIC VAT
appeals may well, in the wake of this ruling, be less exclusively concerned with a trader’s due
diligence procedures and more with the overall features of a transaction. In simple terms: is a
transaction too good to be true, and can the only reasonable explanation for this be that
there is a fraud?

As Lord Justice Moses concludes, although the burden of proof lies with HMRC if a trader’s
right to deduct input tax is to be denied, it is also necessary to examine the surrounding
circumstances of a transaction or series of transactions in order to establish whether or not a
trader may be termed a “participant” in the fraud.

A trader, who chooses to ignore circumstances which can only reasonably be explained by
virtue of the connection between his transactions and fraudulent evasion of VAT, participates
in that fraud and, by his own choice, deprives himself of the right to deduct input tax.

All in all, this judgment, whilst not delivering the coup de grace hoped for by some to HMRC’s
“means of knowledge” arguments, provides food for thought, and represents a welcome
move away from the almost slavish devotion to examination of due diligence which has been
such a feature of MTIC VAT appeals.

There is nothing to fear here for those traders who are able to present a solid, credible mode
of trading and demonstrate that they have taken proper, reasonable precautions in the
market to safeguard against becoming tainted by fraud.

Head of Tax Disputes & Litigation Group

Please contact Don Mavin on +44 (0)20 7417 0417 if you would like to discuss
any aspects of the above article further.


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