Article by David Patrickson, Head of VAT, The Taxserver.
Published in the August 2001 issue of Tax Adviser.
The prosecution or the defence of a VAT fraud case is, in reality, neither an art nor a science, although it retains critical elements of both. As is common in the world of the arts, and in spite of one’s best intentions, where one ends up in a fraud case is often in the lap of the gods. And yet the prosecution of such a case is governed by processes and procedures as rigid as the laws of physics or mathematics and these processes are vital in maintaining the rule of law.
A typical case would follow a path not dissimilar to the following. A fraudulent event is alleged to have taken place. It is not necessary at this point to examine the legislation that constitutes what may or may not be a fraudulent event; in any case the matter is often entirely subjective, in the early stages, at least. The prosecutors gather such evidence as they can to support their case, and the accused and his defenders construct an argument disproving this evidence. If the parties cannot reach agreement the issue proceeds into the courts or the VAT and Duties Tribunals. Here, the case is heard in accordance with the procedures that have been laid down for these institutions. Where a case comes before the VAT and Duties Tribunal, the procedures are laid down in the Value Added Tax Tribunal Rules 1986 (SI 1986/590).
This being the case, with such a well-established framework from which to work, it is unfortunate when either party to a case fails to follow the rules to such an extent that it scores an own goal. When such an event takes place it is inevitable that a degree of comment is bound to follow; if for no other reason than to reinforce the basic principles.
The own goal that is of concern here arrived with the case of A & D Goddard v C & E Commrs, heard in the High Court on 14 March 2001, before The Hon. Mr Justice Lightman, with the judgment issued some six days later.
Before looking at the circumstances of the case, we should spend some time considering the background that ultimately led to the judgment and the quite damning comments made by Mr Justice Lightman
The single market
In VAT fraud, as in almost every other aspect of modern life, fashion plays a significant part. This fashion is invariably driven by contemporary circumstances. It is currently the case that goods can move in transactions between VAT registered businesses in different member states of the European Community without VAT having to be charged by the vendor, as long as he can demonstrate that the goods in question have left his country.
The introduction of The single market in 1993 removed the long-established fiscal frontiers between member states. This set of circumstances has led to the development over recent years of a particular kind of fraud that has come to be known as a carousel fraud, and which has now reached an epic and damaging global scale. The name derives from the manner in which transactions are orchestrated so that the goods in question can be transferred between parties, with the sales and purchases being manipulated giving the appearance that they are moving on a carousel.
A typical series of transactions would follow a pattern something like this:
UK Aco, a company registered for VAT in the United Kingdom, acquires electrical goods from Frenchco, a trading company in France. UK Aco sells the goods to UK Bco, another company registered for VAT in the United Kingdom, charging VAT at the standard rate on the transaction as the goods are in the United Kingdom at the time of the sale. UK Bco sells the goods to an overseas company, possibly even Frenchco again. Because the goods leave the United Kingdom, UK Bco charges no VAT on the transaction.
In normal circumstances UK Aco would account for output tax on its sale transaction and UK Bco would recover the same amount of VAT by way of input tax in respect of its purchase. In the classic fraud scenario, however, UK Aco does not meet its obligation to account for output tax and goes missing. UK Bco, however, seeks to recover the VAT it has been charged as deductible input tax. To assist in the mechanics of the fraud, the two UK companies would be on different VAT accounting staggers so that input tax entitlement falls due before there is a liability to account for output tax.
The methodology is simple because it mirrors the circumstances of millions of legitimate transactions taking place every year, albeit that the legitimate transactions do not incorporate the default in accounting for output tax. The taxation authorities have the problem of identifying and moving against the bogus transactions without penalising those parties who are involved in legitimate trading. The problem is pan-European, felt particularly in France, Germany, the Netherlands and Spain. Terrorist organisations and the Mafia see it as a way of laundering funds gained from other illegal operations such as drug-dealing. Carousel fraud is estimated to be costing the UK alone as much as £2.2 billion a year, and, worryingly, this figure is rising.
Into this Europe-wide boiling pot has fallen A & D Goddard, a partnership that runs a hotel and a caravan park in north Wales. The business registered for VAT in 1991 and there appears to be no suggestion that they have a history of fraudulent activity.
Some time around March 1999 the partnership began dealing in mobile phones, buying the goods from another UK business, Alpha Communications Ltd, and selling them to an overseas business, GSM Europe Mobile Distribution Ltd. The partnership had borne VAT on the purchase of the goods, but had not charged VAT on the sale as the goods left the United Kingdom.
The partnership claimed VAT of £519,328.25, but Customs & Excise wrote to them stating that the transactions ‘could not be considered to be supplies made in the normal course of a business being carried on’, and refused to authorise repayment. There were a number of factors which led Customs to come to the conclusion that the transactions may be a sham. First of all the partnership did not appear to have taken physical possession of the goods. There were timing differences with goods seemingly delivered to GSM before the partnership had apparently purchased them. Payments in respect of the Goddard’s purchase and sale of the goods went through the client account of a company called Eurofreight Ltd, who had acted as freight forwarding agents.
Goddards’ appeal – refutes Customs allegations
Goddards appealed to the VAT and Duties Tribunal on 26 May 1999, claiming that the transactions were genuine and refuting the allegations made by Customs. However, no agreement was reached and the case proceeded.
In their statement of case, served to the tribunal on 6 August 1999, under the provision of s. 7 of the Tribunal Rules, Customs stated that ‘the alleged transactions were not genuine supplies’ and that they bore ‘the hallmarks of a carousel fraud’. A significant observation.
The first hearing
The first hearing before the tribunal took place on 15 May 2000. As could have been expected, the question arose as to whether the hearing should be postponed until after the likely prosecution of the partners for the alleged fraud. The tribunal gave Customs one month to show cause why fraud was alleged and to let them know if a criminal investigation was continuing.
The second hearing
In the second hearing, which took place before the tribunal on 3 July 2000, Customs confirmed that it did not intend to pursue criminal proceedings and withdrew the allegations of fraud against the partners. As a consequence, the tribunal directed that the paragraphs in the Customs statement of case referring to these matters should be struck out.
Because the relevant paragraphs contained the essence of the Customs case, the tribunal directed that they should have until 1 August 2000 to amend the statement of case, to set out grounds for opposing the appeal that were not based on the allegations of fraud. Failure to comply with the direction would result in the appeal being allowed.
It is here that things appear to go horribly wrong with the Customs case. Whether or not it was the realisation that without the fraud allegation they had no case is not known, but their actions became confused. For four weeks they seem to have done nothing. They certainly did not produce an amended statement of case as the tribunal had directed. On 31 July 2000 they made a written application to the tribunal that the allegations of fraud be reinstated, that the relevant paragraphs in the statement of case should stand, and that the tribunal’s direction of 3 July 2000, be deleted. The correct approach would have been to lodge a formal appeal against the direction. Understandably, the partnership made a cross application for a direction that their appeal should stand as Customs had failed to comply with the direction of the tribunal.
Seven days requested
Both applications were heard before the tribunal on 5 September 2000. It was noted that Customs had only instructed counsel to attend on the actual day of the hearing and had given inadequate instructions. Furthermore, they had not sent any other representative who was capable of remedying these defects. Counsel for Customs requested a further seven days in which to produce an amended statement of case. This was rejected and the partners’ appeal succeeded. Clearly, by this stage, no other outcome could have been expected.
However, this was not the end of the affair. In spite of having failed to follow the direction of the tribunal and the Tribunal Rules themselves, Customs then took the matter to the High Court to have the tribunal decision reversed. Once again the case went against them. Mr Justice Lightman dismissed their appeal and in the concluding paragraph of his judgment he expressed his concern at the sequence of misjudgments on the part of Customs that may have led to the partnership receiving a substantial refund to which they may not have been entitled.
Prosecution case a shambles
Whether or not there was a sustainable case of fraud here we do not know, but the prosecution of the case was a shambles. Worryingly, the Customs approach suggests a belief that, as prosecutors, the rules should not apply to them.
Unfortunately this is not an isolated case. There is evidence to suggest that in the rush to prosecute cases, corners are being cut. Poorly prepared lawyers are nothing new. We hear of cases being thrown out because of search warrant irregularities. We see criticism of the methods used by Customs investigators in the national press. At a lower level we hear of assessments being thrown out by the tribunal even after evidence of suppression has been identified, because best judgment was not exercised in calculating the due amount.
The rules of law are clearly stated and exist as boundaries within which the authorities must operate both for their own benefit and for the protection of society.
Anything else smacks of anarchy.
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August 2001 by