HMRC fail to show that only reasonable explanation was that mobile phone transactions were connected with MTIC fraud

The Tribunal ruled that although the trader should have realised that it was more likely than not that the transactions were connected to fraud, HMRC could not show that this was the only explanation for the trades.

JDI Trading Limited, which was part-owned by Carphone Warehouse co-founder Guy Johnson, was party to mobile phone transactions with parties who were involved in missing trader intra community (MTIC) VAT fraud. HMRC denied it VAT input tax recovery in respect of the transactions.

MTIC fraud involves fraudsters exploiting the way VAT is treated within EU trading where the movement of goods between jurisdictions is VAT-free. It involves a fraudster charging VAT and then absconding with the VAT and not paying it over to the tax authorities.

The fraud was initially used in sales of mobile phones and computer chips, but in the last few years it has spread to other areas including energy-related supplies. Key areas are precious metals; carbon credits under the EU Emissions Trading Scheme, and energy and oil products trading. As well as pursuing the fraudsters, HMRC denies VAT input tax repayments to those in the chain who "knew, or should have known" that the transaction was fraudulent.

The owners of JDI were aware that MTIC fraud was prevalent in the mobile phone market and that HMRC could deny input tax recovery where fraud had occurred, if JDI had not taken steps to ensure that they were not dealing with fraudsters. JDI therefore instructed accountancy firm PwC, using an employee of PwC who had previously spent nine years with HMRC specialising  in the detection and prosecution of MTIC fraud, to advise on its due diligence procedures and to approve JDI's customers and suppliers.

However, despite its procedures, which were not followed to the letter in every case, JDI become involved in some transactions where there were fraudsters in the supply chain.

In the 2006 case of Axel Kittel v Belgium & Belgium v Recolta  Recycling SPRL  the Court of Justice of the European Union (CJEU) decided that "traders who take every precaution which could reasonably be required of them to ensure that their transactions are not connected with fraud… must be able to rely on the legality of those transactions without the risk of losing the right to deduct the input VAT"

However the judgment went on to say that "a taxable person who knew or should have known that, by his purchase, he was taking part in a transaction connected with fraudulent evasion of VAT must, for the purposes of the Sixth Directive, be regarded as a participant in that fraud, irrespective of whether or not he profited by the resale of the goods".

The decision of the CJEU in the Kittel case was considered by the Court of Appeal in 2010 in the case of Mobilx, where Lord Justice Moses said of the test in Kittel: "if a trader should have known that the only reasonable explanation for the transaction in which he was involved was that it was connected with fraud and if it turns out that the transaction was connected with fraudulent evasion of VAT then he should have known of that fact. He may properly be regarded as a participant for the reasons explained in Kittel."

He went on to say that the Kittel principle "does not extend to circumstances in which a taxable person should have known that by his purchase it was more likely than not that his transaction was connected with fraudulent evasion. But a trader may be regarded as a participant where he should have known that the only reasonable explanation for the circumstances in which his purchase took place was that it was a transaction connected with such fraudulent evasion".

In the JDI case HMRC argued that as the deals were "too good to be true" JDI must have known that it was dealing with parties involved in fraud. However, the Tribunal was not persuaded by these arguments. The decision states "if the intention had been to enter into fraudulent transactions JDI would not have appointed PwC to undertake due diligence on its behalf".

There were some preliminary applications in the case concerning the admissibility of some of the evidence HMRC sought to rely on together with the question of whether HMRC could rely on further evidence of fraud on behalf of other parties to JDI's transactions.

Stuart Walsh, a tax disputes expert at Pinsent Masons, the law firm behind Out-law, said that although taxpayer wins in MTIC fraud cases concerning mobile phones "will always draw attention", the actual decision itself reaffirms a well established line of case law. 

He said that two points of interest emerge from the case. "First, the Tribunal directed that it would exclude from its consideration serious allegations of fraud made by HMRC against third parties on the basis that they had not been adequately pleaded in advance of the hearing, as well as ruling out HMRC evidence on the grounds of appropriateness, relevance and admissibility. This demonstrates that the Tribunal is increasingly willing to adopt procedural rules applicable in the High Court if it considers it necessary to do so having regard to its overriding objective to deal with a case fairly and justly."

Walsh said that the second point of interest is that "even in circumstances where it is established that the transactions at issue were part of a chain contrived for fraudulent effect with the person at the start of the money chain being the same person at the end, it does not automatically lead to a conclusion that a taxpayer, such as JDI, should have known that the only reasonable explanation for the transactions was that they were connected with fraud".