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Andrew Needham, Director of VAT Solutions (UK) Ltd, highlights a selection of recent VAT decisions.

High Court allows taxpayer's appeal against refusal of monthly VAT returns by HMRC

The Appellant is a German car manufacturer which was allowed to adopt monthly VAT returns with effect from 1 December 2002 (further enquiries were not made by HMRC at the time).  The Appellant buys all of the cars (Minis) made by its UK subsidiary, with the level of cars exported being such that it is permanently in a VAT repayment position.

The UK subsidiary is in a net VAT payment position, and makes quarterly VAT returns. By 2006 HMRC had taken exception to the cash flow implications of the VAT return position, and on 22 June 2006, it directed the Appellant that it could no longer make monthly VAT returns, and that it would be placed on quarterly returns with the same period-end dates as its UK subsidiary.

In the judicial review, the Appellant asked the Court to quash that direction. The Judge rejected arguments that HMRC had no power to issue such a direction, and that the policy of HMRC was incoherent, irrational, or in breach of EU law.

Having found that there was nothing inherently wrong with the HMRC policy in this area, the Judge went on to consider the validity of the decision making process in the application of that policy to the Appellant’s circumstances.

The Judge looked at the facts, and concluded that the interposition of AG gave the corporate group no new benefit (in terms of a significant cash flow advantage) that the corporate group would not have obtained had the subsidiary been the exporter instead. The Judge commented that the mere existence of a principal company on quarterly returns and a subsidiary on monthly returns was not conclusive evidence of a cash flow advantage, when looking at the overall position, and to suggest that situation to be unjustified or unintended was not logical or fair.

As such, the application of the HMRC policy in this way was flawed (there was no suggestion of any manipulation by the Appellant to enhance any perceived advantage, and the Appellant argued that the supply of all Mini cars through itself had sound commercial reasoning). The appeal was allowed.

[For further developments on this case, see Steve Allen's more recent article in VAT Case Update II - November / December 2008 - Ed]

R (On the application of BMW AG & Others), High Court Queen’s Bench Division, 9 May 2008

High Court says that payment handling services for dental care are exempt supplies

Under a service entitled ‘Denplan’, patients agree to pay their dentist a fixed monthly sum which covers them for a specified level of dental care at no extra cost. Denplan agrees with the dentist to collect these sums from the patients by direct debit. After deducting an insurance premium and its own fee, Denplan transfers the balance to the dentist via BACS. Denplan's fee, which was the subject of the dispute, averages at about 71p per monthly payment. The VAT Tribunal had earlier ruled that the fee was for a mixed supply, but which would be predominantly exempt. Both HMRC and the Appellant disagreed with the Tribunal decision, with HMRC arguing that the whole fee was taxable, and the Appellant arguing that it was all exempt.

The High Court found predominantly for the Appellant, finding the fees by Denplan to be exempt. The Court agreed with the Tribunal that the payment handling service was the principal supply, with some of the other services provided being ancillary. The only exceptions to this were services supplied to dentists with no plan patients (which consisted of the use of a restricted area of the website and trademark), and guidance provided on buying and selling goodwill. These were found to be separate taxable supplies, as they were not ancillary to the payment handling service.

HMRC sought to distinguish Denplan from the ‘Bookit’ and ‘FDR’ cases. They argued that in Bookit, a binding authorisation code ensured the transfer, whereas in Denplan, the transfer was by monthly direct debit. In FDR, HMRC said the supplies were made to banks rather than bank customers as per Denplan.

In his decision, the Judge concluded that it did not matter who supplied the service. The test of what constitutes an exempt transfer of money is functional. A transfer is the execution of an order for the transfer of a sum of money from one account to another. Executing such an order changes the legal and financial situation between the parties (per the test set out by the ECJ in ‘SDC’). The cause of the transaction is not relevant, nor does there have to be absolute certainty that the transfer happens. The critical issue for exemption is that the actions of the service provider cause a transfer to be effected. The service provider does not need to be carrying out an 'outsourced banking function'. The Judge was critical of HMRC trying to argue that point, which he described as an unprincipled attempt to marginalise ‘Bookit’ by way of a damage limitation exercise. The appeal was allowed.

Axa UK plc, High Court, 22 May 2008

Comment: This case may potentially widen the scope of the payment handling exemption. The application of SDC, FDR and Bookit is likely to strengthen the position of similar businesses trying to secure VAT exemption, whilst weakening HMRC's attempts to limit Bookit-type structures. The decision also reinforces the Courts’ approach to establishing the principal supply, only applying a different liability to supplies which are clearly not ancillary in nature.

Tribunal finds mainly for HMRC in 'proof of knowledge' MTIC fraud case

The first of two new additions to the list of Missing Trader Intra Community (MTIC) ‘proof of knowledge’ cases. In this one, HMRC withheld the input tax claimed in connection with 29 export sales in March and April 2006, under the joint and several liability legislation (s77A VATA 1994). HMRC argued that the sales were part of fraudulent chains, and that the Appellant either knew or should have known that the transaction chains originated with defaulting traders.

The Tribunal found no fewer than thirteen bits of evidence that should have triggered ‘serious concern’ or suspicion in the mind of a ‘reasonable businessman’. Due to the  detailed analysis of the issues raised in the ECJ case of Axel Kittel (C-440/04), the scope and interpretation of the phrase ‘should have known’ in UK law and litigation, and the problems with the transactions and questions which should have been raised by the Appellant as a result, this case may be a useful reference point for joint and several liability matters. In closely examining the tests which HMRC would expect a business of this nature to carry out for the purposes of 'flushing out' potential fraud, the case provides guidance on the responsibilities of a business operating in a chain to know its customers and its customers' customers.

HMRC contended that the Appellant’s VAT recovery on the exports should be denied in full; any input tax withheld over the amount of the defaulted output tax should be seen as an incentive against fraud or connection with fraud and possibly considered in the light of a penalty. The Tribunal considered that the purpose of the legislation was to prevent a theft rather than recover a loss or impose a penalty, and that the purpose and the neutrality of the common system of VAT is maintained by denying only the tax evaded. Therefore, the Tribunal decided that the input tax withheld should not include the VAT actually paid by the buffers in the chains between the Appellant and the defaulting traders, leaving it to HMRC and the Appellant to agree the amount which should be repaid. Furthermore, the Tribunal limited the input tax deduction to only 26 of the transactions in question, since on closer examination, the others could not be positively traced back to a defaulting trader. These conclusions seem to be the most fair and reasonable outcome for both the Appellant and HMRC.

It is worth noting that this case may not yet be finished, as the Appellant made an additional argument that the HMRC burden of joint and several liability on the exporter, denying VAT recovery only at the end of the chain, discriminates unlawfully against exporters under the EU guarantee of a free market between Member States. While the Tribunal agreed that the impact of the legislation makes it more difficult to be an exporter than a seller on the UK domestic market, it found that the question of whether UK VAT legislation is valid and legal under EU law was outside the scope of the hearing. However, after the release of the preliminary decision, the Tribunal invited both parties to indicate within 14 days whether they wished any question to be referred to the ECJ. The appellant served notice, and the Tribunal concluded that the decision is subject to any reference that it might decide to make.

Honeyfone Ltd (VTD 20,667)

Tribunal finds for HMRC in 'proof of knowledge' case

This second proof of knowledge case concerns the input tax claimed in the period April to June 2006, which was again withheld under s 77A VATA 1994.

The Appellant argued that as its due diligence had been described by HMRC as ‘better than that undertaken by most traders’, it had followed the requirements of Public Notice 726, and followed HMRC’s suggestions for improvement. It had thus satisfied the test laid down in ‘Kittel’ to take ‘every precaution which could reasonably be required’. HMRC, therefore, had no right to withhold the input tax. However, HMRC felt this was not enough to protect the trader, and that the nature of the Appellant’s knowledge was paramount. In addition, a senior employee of the Appellant (though not a board member) had the benefit of knowledge from prior employment on the background of many of the Appellant’s defaulting suppliers. The fact that this information was unknown to the Directors was no excuse (Meridian Global Foods refers): The Appellant could not avoid the consequences of Kittel by delegating to a non-director employee. Therefore, the ‘should have known/could have known’ test applies as much to non-office holding staff, as it does to its directors. In Kittel, a provision was laid down that tax could be withheld where the trader ‘knew or should have known’ that there was fraudulent activity in its supply chain. The directors were fully aware of fraud within the mobile phone and CPU markets, and were aware of the nature of MTIC fraud.

HMRC had made the Appellant aware on numerous occasions that in every case where its transaction chain had been fully traced, the chain was found to originate with a defaulting trader. The fact that the Appellant had then acted to cease trading with those suppliers was insufficient. Furthermore, although HMRC's granting of monthly returns during the period of disclosure and discussion could be seen as a validation of the way the Appellant was conducting its business, this did not mean it could ignore its responsibility to continually refine its precautionary checks as laid down in Kittel. HMRC will never provide a definitive checklist to counter MTIC fraud as this would "merely enable fraudsters to ensure they satisfy such a list". Hence, HMRC look beyond 'box-ticking' procedures to check fraud, and instead examine directors’ attitudes and their commercial motivations to gauge the sincerity of their ethical code and desire to protect the revenue.

HMRC seems to have been influenced by the Appellant’s change from supplying mobile phones (which it knew a lot about) to the risky trade of CPUs (about which it knew very little). In this instance, HMRC argued that the only way an honest trader could defend itself from being connected with fraudulent chains would be to cease trading in CPUs.

The Tribunal ruled that, by April 2006, the Appellant should have known it could not be confident of the integrity of its supply chains, as its due diligence had not done enough to avoid connections with fraudulent chains in every transaction investigated by HMRC. It should have been apparent that if it continued to deal in CPUs, its transactions were likely to be connected to fraud. As such, it forfeited its right of input tax recovery.

Mobilx Ltd (In Administration) (VTD 20,687)