Many companies operating in the mobile telephone and computer chip grey markets will be only too familiar with the strategy of extended verification employed by HM Revenue and Customs (“Customs”). There are signs, however, that this strategy is being applied to exporters in other sectors, and therein lies the problems for the affected businesses
For many months, Customs have withheld VAT repayment claims submitted by exporters in the mobile phone and computer chip market whilst they conduct lengthy and far-reaching enquiries into every constituent part of each transaction chain in an attempt either to find a defaulting trader within the UK, or evidence of a carousel-type artificial scheme designed to extract VAT from the UK tax system.
With their defeat in the ECJ in the case of Bond House et.al, the previous argument by Customs that transactions in a carousel fraud were non-economic in nature fell, and the Court found that the fact that a carousel fraud was in operation was not, in itself, sufficient justification for denying the fundamental right to reclaim input tax.
However, Customs drew comfort from a substantial and crucially important caveat within the judgement – namely; the right to deduct input tax can be withheld if a trader knew, or had the means of knowing, that the transactions in which it was involved were vitiated by fraud.
Further good news was to come for Customs with the release, in July last year, of the ECJ’s judgement in the case of Axel Kittel/Recolta Recycling. The Court underlined the crucial issue of knowledge, finding that “…a taxable person who knew or should have known that, by his purchase, he was taking part in a transaction connected with the fraudulent evasion of VAT must…be regarded as a participant in that fraud, irrespective of whether or not he profited by the resale of the goods”. This has become widely known as the “means of knowledge” argument.
Customs now routinely cite these two cases in the letters sent out to exporters awaiting decisions on VAT repayments, and both judgements feature prominently in the regular statements outlining Customs’ position on the verification of VAT repayments.
In fact, thanks to the ECJ, Customs have rarely had to invoke the much-vaunted “joint and several liability” powers open to them under Section 77A of the VAT Act 1994. The “means of knowledge” argument effectively removes the need for a Joint and Several Liability Notice and achieves the same result – a licence to Customs to withhold input tax whilst conducting protracted enquiries into whether or not a trader could or should have known that a fraud was in operation.
The VAT Tribunals have also added to the debate by setting out, in their decision in the case of Dragon Futures, a set of objective factors which should be taken into consideration in determining whether a trader knew or should have known that there was fraud in the supply chain.
Customs are now, as a matter of routine, relying upon these decisions in support of their current policy of withholding VAT repayments. This fact in itself may not seem terribly newsworthy, but it represents a change of direction and emphasis on the part of Customs. The stage is now set for a concentrated strategy of input tax denial across all businesses which are engaged in exports and involved in MTIC-type transaction chains.
Section 77A of the VAT Act 1994 limits the imposition of the VAT joint and several liability provisions to an extremely narrow band of trade – in simple terms, mobile telephones and accessories and computer chips and IT peripherals.
However, the means of knowledge argument is not similarly confined and may be applied to any business trading in anything – from Mars Bars to magnets. The ECJ case of Bond House et al, which initially seemed to represent a body blow to Customs has in fact (with the publication of Kittel) given them a useful alternative means of withholding VAT repayments from, if they choose, the entire range of export traders.
The ECJ, in ruling in favour of Bond House, has settled in law a principle which Customs are now applying to businesses as diverse as dealers in alcoholic drinks, exporters of clothing, general dealers and exporters of solar panels.
The practice of withholding VAT repayments from exporters pending the extended verification of transaction chains has already borne fruit for Customs, with Paymaster General, Dawn Primarolo, telling a House of Lords Select Committee that Customs policies had resulted in “a massive drop” in attempted VAT fraud.
There is no doubt that, in the present climate, any business which exports goods and routinely submits VAT repayment claims to Customs should take steps to assure its chains of supply, and should institute due diligence procedures in order to avoid being caught up in fraudulent supply chains. The stringent measures currently applied to the mobile telephone and computer chip trade sectors are now being used by Customs across the board, and businesses can expect to have every aspect of their trading scrutinised in minute detail.
Vantis' Customs Investigations & Litigation team provide a full range of risk assessment and due diligence advice to companies in all trade classes, and we are able to implement new procedures or enhance those already in place in order to minimise the risk of VAT repayments being withheld.
Please contact Don Mavin for more information.