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Steve Allen, Director of VAT Advisers Ltd, highlights a further selection of recent VAT case decisions.

High Court Finds For Taxpayer that It Could Not Have Known about Fraudulent Transactions

Another MTIC ('Missing Trader Intra-Community Fraud', a.k.a. 'Carousel Fraud') case, this one concerned with HM Revenue & Customs' (HMRC's) refusal to repay a net balance due on the basis of the Appellant’s participation in fraudulent evasion. The Tribunal had earlier found for HMRC.

The Appellant was a participant in a 'clean' chain of transactions for the sale and purchase of mobile phones with an alleged 'contra-trader' (as defined in Olympia Technology Ltd). The Appellant’s input tax claims were blocked by HMRC on the basis that its transactions necessarily connected it with the contra-trader’s involvement in a separate 'dirty' chain of fraud.

HMRC argued that from the available evidence, the Appellant knew or should have known it was involved in a transaction connected with fraud. HMRC said they had warned the Appellant in general of the risks of MTIC fraud, and that it had not carried out due diligence in relation to its suppliers, customers, or the contra-trader. The Court considered the Tribunal's decision which was based on affirmative answers to the following four questions:

1. Was there a loss to the Revenue?
2. If so, did that loss result from fraud?
3. If so, were the Appellant’s transactions connected with that fraud? and,
4. If so, should the Appellant have known the purchases were connected with that fraud?

The fourth question comes from a test in Kittel, and due thought was given to the suggested 'narrowing' (Livewire) of the term 'connected' in subsequent case law (Netto Supermarket GmbH, Teleos plc). The Appellant argued there was an insufficient connection between its transactions and the fraudulent evasion of VAT by parties in the 'dirty' chain, and that even if there was, it did not have a ‘means of knowledge’ to justify a conclusion that it should have known about that connection. In its findings, the Court considered the terms 'connection' and 'knowledge'.

The Appellant argued that the character of a particular transaction cannot be altered by prior or subsequent transactions. There was no logical connection between other chains and the clean chains it was involved with. In Livewire, the question of 'connection' was considered in relation to knowledge. The Court pointed out that Livewire did not consider the inevitable connection between clean and dirty chains where the contra-trader was party to both because a connection was assumed. The Judge went on to decide the appeals on the basis of taxpayer knowledge. There is a connection in that the right to reclaim by the claiming trader in the dirty chain is transferred to his equivalent in the clean chain.

Not all persons involved in either chain, although connected, should be liable for any tax loss. The control mechanism lies in the need for either direct participation in the fraud, or sufficient knowledge of it. For this reason, it is important that the tax losses in question are only used once. Thus, having used the tax losses attributable to parties in the dirty chain (by allocation to the tax reclaimed by the Appellant) they are no longer available to be allocated to other transactions or claims.

Having established there was a connection, the Court looked at whether the Appellant should have known if the transactions were connected with VAT fraud. There are two frauds: 1) the dishonest failure to account for VAT in the dirty chain, and 2) the dishonest cover-up of that fraud by the contra-trader. In this case, the Tribunal did not find that the contra-trader had been fraudulent. The Court considered whether the 'sufficient to protect' test applied by the Tribunal to the Appellant’s due diligence checks was too strict, and found that it was. The fact the contra-trader formed a connection between the clean and dirty chains, was not enough to show the Appellant ought to have known of the fraud in the dirty chain. At the time it entered into the clean chain, there was no dirty chain it could have known about, nor was fact of its existence inevitable in the sense of being pre-planned.

Blue Sphere Global Ltd, High Court Chancery Division, 22nd May 2009

High Court says Split Sale of Land and Construction for Holiday Homes is Single Supply

An interesting case about the supply of holiday homes, where two connected, but separately VAT registered companies, enter into contracts with a customer. Company 1 supplies the land on which the holiday home is built (‘Landco’), and is taxable as an excluded item under VATA 1994 Sch 9 Group 1 (Item 1(e) and Note 11).  Construction services are supplied by company 2 (‘Buildco’), which zero-rates its supplies on the basis that they are in the course of the construction of new dwellings under VATA 1994 Schedule 8 Group 5 Item 2.
 
Landco markets the holiday homes, and, in most cases, sells vacant plots to customers plus VAT. Following payment of a reservation fee, Landco enters into a lease agreement, and once it has been signed, the customer enters into a separate agreement for the construction services with Buildco (comprising six distinct phases). In theory, customers do not have to use Buildco, but everyone to date has. All payments are made by the customer to Buildco, apart from when construction work has already started on a plot before it is sold. In that case, Landco invoices the customer for stage payments to that date, including VAT.

In February 2008, HMRC assessed the Appellants for standard-rated construction services, and gave the Court the following three arguments in support of this:

1. Single Supply - when the essential features are considered (ignoring the two separate contracts) there is a single taxable supply of holiday home by Landco
2. Joint Supply – HMRC originally had an alternative argument that Buildco made a supply of a completed holiday home to the customer. This was amended to argue there was a joint supply by the two companies. Buildco’s share of this taxable supply was the value of its construction services.
3. Abusive Arrangements – if the technical arguments fail, HMRC say the arrangements are abusive on the basis they resulted in a tax advantage contrary to the purpose of the Directive, and that the essential aim was to create a tax advantage. Following Halifax, the arrangements should be redefined as a single taxable supply of a holiday home.

In reaching its decision, the Tribunal evaluated the three HMRC arguments as in the same order they had been presented.

On Single Supply, the Tribunal found CPP could not apply in terms of the supplies, as there was no principal and ancillary service. It found the construction services were a substantial business in their own right. The economic linkage argument in Levob was distinguished on the basis that this case concerned one supplier. The Appellants said it was not possible to treat supplies by two different suppliers as a single supply, citing Telewest. The Tribunal did not address this specific point, but did dismiss Telewest as being more concerned about one supply being split into two than two supplies being recast as one. The Tribunal dismissed HMRC’s argument on the basis that it was not possible to classify the supplies as a single supply using case law.

For the issue of Joint Supply, the Tribunal unequivocally dismissed HMRC’s argument. Landco supplies the land, and the time of supply is on payment or invoice, both of which are prior to Buildco’s involvement. Buildco has no interest in land, and can only supply construction services. The issue is thus whether the services are supplied to Landco or the customer.

Regarding Abusive Arrangements – In looking at the Halifax test the Tribunal found a tax advantage was obtained. This was achieved simply by a reduction of the taxable amount. The fact that an element of consideration paid for a new holiday home is VAT free is contrary to the Directive. The Tribunal then looked at whether the essential aim was to create that tax advantage. On this point the Tribunal looked at how the contractual arrangements were constructed. The Tribunal concluded that the way in which the holiday home is provided is aimed to create a VAT advantage.  This was supported by the documentation and the packaging of the supplies. The Tribunal referred to the ECJ Part Service case, which suggested looking at the economic viability of a business when considered in isolation, and the profit margin it obtained. As Buildco’s profit margin was only 3-5%, there was a question over its viability as a stand alone business. However, the Tribunal did not consider what a typical construction industry profit margin might be. This subjective approach is a bit surprising given the emphasis placed upon this, and the Tribunal’s role as a fact-finding body.

In finding for HMRC, the Tribunal then turned to the issue of redefining the transactions. Whilst some abusive arrangements can be complex, this case was relatively straightforward. The Tribunal confirmed that redefinition would result in a single standard-rated supply of a completed new holiday home being made by Landco.

It is clear the Tribunal did not consider the contracts a sham. It is also clear the Tribunal did not think it could recast the supplies under those contracts using the approach adopted in Eastbourne Town Radio Cars. However, this did not stop it considering Halifax.

We have seen a number of post-Halifax abuse cases in the Courts, but some of them were implemented pre-Halifax when arrangements were entered into primarily for VAT purposes. This case is interesting in that the arrangement was not only in place from the start of the business, and there were some valid commercial reasons (e.g., a requirement from the funding company to hold the land asset in a separate company). The taxpayer even got confirmation from HMRC that their VAT treatment was correct in 1999. The Tribunal placed emphasis on the ‘stand alone’ factors when examining the essential aim test, including the low profit margin for Buildco. This suggests the taxpayer would have had a stronger case if it had ‘shifted’ more value to the zero-rated construction.

It is worth noting that, in this specific case, HMRC did not succeed in applying 'single in supply' case law to supplies by separate companies. However, HMRC was successful in achieving the required outcome of securing VAT on the full consideration paid, albeit that this was only on the basis of abuse.

Lower Mill Estate Ltd and Conservation Builders Ltd (TC000016)

High Court says Treatment of Mechanised Bingo and Gaming Machines Breached 'Principle of Fiscal Neutrality'

This case was an appeal by HMRC against two VAT Tribunal decisions concerning the UK’s application of the gaming exemption. 

In the first appeal, the Appellant made supplies of mechanised cash bingo played under either of the Gaming Act 1968 s 14  or s 21.  By virtue of  VATA 1994 Sch 9 Grp 4 item 1 Note (1), s 14 games were taxable while s 21 games were exempt. The Appellant made a repayment claim of £36m for the period January 2003 to December 2005 in respect of s 14 games, contending that the differing tax treatment failed to comply with the Community principle of fiscal neutrality.

The VAT and Duties Tribunal allowed the taxpayer’s appeal against refusal of its repayment claim, holding that HMRC’s submission that there was no distortion of competition centred on the fact that the supplies were all made by the taxpayer. That approach was incorrect: the infringement did not depend on the circumstances of the supplier.

In the second appeal (‘the slots appeal’), the taxpayer claimed a repayment of VAT in the sum of £26m for the period October 2002 to December 2005 on the basis that income from gaming machines covered by Gaming Act 1968 s 31 and s 34 had been subject to VAT, but comparable machines falling within Gaming Act 1968 s 21 or Lotteries and Amusements Act 1976 s 16, although essentially similar, had been treated as exempt. The appeal was against the refusal by HMRC to allow the repayment claim.

The Bingo Appeal

The Court said that a UK taxpayer who established that he provided goods or services which were similar (in the sense required by the principle of fiscal neutrality) to those supplied by another economic operator, and were thus in competition (in the sense in which that was to be understood for the purposes of the principle of fiscal neutrality), but whose services were treated differently for VAT purposes, had established that there was a distortion of competition (and that the principle of fiscal neutrality was engaged). He had established that he had been subjected, without justification, to a different tax regime.

The Slots Appeal

The tribunal had adopted the correct approach. In the phrase ‘the element of chance in the game is provided by means of the machine’ the ‘machine’ to which reference was made was obviously that which was constructed for playing the game of chance, that which the player played and that into which a coin or token was inserted (reading the Note to VATA 1994 Sch 9 Grp 4 with the Gaming Act 1968 s 26). It was a question of fact in each case whether that determining event was produced by ‘the machine’, and fine distinctions might have to be drawn. The principle by reference to which those judgments had to be made was whether the outcome of the game might sensibly be regarded as determined by an external event which the machine recorded or was produced by the machine itself. The random generation of a number in a separate unit which served various player terminals (which might themselves be running different games) was properly regarded as an external event and not one produced by the machine that the player was playing.

The tribunal’s alternative ground for its decision based on administrative practice was also sound in law. On the evidence there was a relevant ‘practice’ under which some comparator machines were not treated as gaming machines (whatever the true position at law) and were treated as exempt from VAT. The acceptance that various operators did not have to pay VAT on supplies made by such machines was part of a considered and coherent approach by the tax authorities and formed the basis upon which tax was declared by operators and collected by HMRC.

In dismissing both of HMRC’s appeals, the Court said that the principle of fiscal neutrality proceeded on the footing that apparently identical or similar goods or supplies would ordinarily be in competition with one another, so that a difference in VAT treatment (which might have consequences for the supplier or for the consumer) would breach the principle of fiscal neutrality: but the authority responsible for the differential treatment might demonstrate that there was no breach of the principle because the goods were not in truth identical or similar (even by the relevant generous test) or (although identical or similar) were not for some other reason in competition (so that the differential treatment had no distorting effect). The ‘competition’ which was being considered was competition between goods (or services), NOT competition between suppliers of goods (or services) and the fact that the taxpayer provided [both] the games or machines in issue was irrelevant.

Rank Leisure Group plc, High Court Chancery Division, 8 June 2009

The above article is taken from VAT Voice, a bi-monthly publication. To subscribe to VAT Voice, visit TaxationWeb's Tax Bookshop (VAT Voice).