Practice and Procedure


PUBLISHED June 11, 2003

An unknowing participant in a "carousel" fraud was not entitled to input tax credit in relation to transactions connected with the fraud as they were devoid of economic substance and as such fell outside the scope of value added tax.Appeal by Bond House Systems Ltd ('B') from a decision of the Commissioners of Customs and Excise dated 19 September 2002 refusing to allow an input tax claim made in respect of VAT period May 2002. B traded principally in computer processor chips ('CPUs'). Of the twenty-seven purchases of CPUs it made from UK traders in May 2002, nine were from SDP Ltd, 16 were from VJ Trading Ltd, and one each was from Larcom and TCHYP. The CPUs were then sold on by way of export to Irish traders. Subsequently, in its return for VAT period May 2002, B sought credit and repayment of VAT in the sum of ?16,287,205 and submitted documentation in support of its claim. Upon receipt of the claim the Commissioners carried out investigations of B with the intention of determining the genuineness of the transactions and the chain of supply. As the delay in repayment put B in a difficult trading position financially it decided to cease trading. Thereafter the Commissioners repaid £8 million without prejudice to their objections in principle to the claim and accepted that £2,732,201 was allowable. By a letter dated 19 September 2002 the Commissioners refused to meet the claim in full and in October 2002 raised an assessment in the sum of £5,267,799 to recover the difference between the sum previously paid to B and the allowable amount of their claim. On appeal B contended: (i) that because it had made taxable purchases in the course of its business of making taxable (if zero-rated) onward supplies and the requisite documentary evidence was held, it was entitled, as of right, to the input tax credit claimed; (ii) that there was no case for the Commissioners to look beyond its transactions where no fraudulent activity was alleged; (iii) that the Commissioners had demonstrated an inability to distinguish properly between what was, and what was not, VAT by treating it differently from other traders identified to having been participants whose output tax and input tax calculations had been accepted; and (iv) the Commissioners approach had breached its human rights and the principles of proportionality and of legal certainty. Whilst the Commissioners accepted that B was not an active particpant in a fraud or even aware of it, and that its transactions were genuine in that the CPUs and the payment for them changed hands on every occasion; it was submitted that the transactions had been devoid of any economic substance and were in fact part of a series, or circle, "a carousel", of transactions whose purpose was not to supply goods but to act as a device for the obtaining of a pecuniary benefit by fraud. It was further submitted that B's ignorance did not confer economic substance on the transactions and that, since illegal transactions were outside the scope of VAT, what B paid its suppliers under the guise of VAT was not VAT at all and it was not therefore entitled to the input tax credit which it claimed.HELD: (1) As the Commissioners acknowledged that the relevant transactions were genuine and that B was not knowingly a party to any fraud, it was for them to demonstrate, on the balance of probabilities, the facts of each of the twenty-seven transactions and, to the same standard, that each was undertaken in the furtherance of a fraudulent or, at least, non-economic activity. (2) Although the Commissioners had developed three concepts to detect and prevent carousel frauds, namely, specific circularity, general circularity and ring fence, they all had the same essential characterisitic of circularity in that a succession of sales of precisely the same goods would be orchestrated by a ringmaster through the hands of several traders but ultimately find their way back to their starting point, ie. there would be sale by an EU trader to a trader registered in the UK; a sale by that trader to another UK trader on which VAT was charged but not accounted for; and a sale by a UK trader to an EU trader. There would also be at least one buffer trader in each series of transactions in order to make tracing by the taxing authorities more difficult but such traders did not always have knowledge of the fraud. (3) So far as general circularity and the issue of a ring fence were concerned in the instant case, the Commissioners had established on the evidence that such patterns existed in relation to twenty-six transactions. It was inconsistent with legitimate trading activity that all of the CPUs purchased from SDP were then sold by B to Fancygrove Ltd in Dublin, and the rapid growth in turnover of SDP and V J Trading, and to a lesser extent B itself, was remarkable. The irresistable inference was that they were (whether or not knowingly) being used in the perpetration of a fraud. (4) Since by the Commissioners' own criteria the evidence of carousel fraud was not established in relation to B's purchase from Larcom, its input tax claim in respect of that purchase (£96,616.80) would be allowed. Each of the remaining twenty-six transactions identified by the Commissioners formed part of a circular series whose objective was fraudulent. B was ignorant of that fact but was impudent in its dealings and its directors failed to ask themselves obvious questions. (5) Notwithstanding B's innocence of any wrongdoing, its relevant transactions were devoid of economic substance. The criteria by which the twenty-six transactions had to be judged were wholly objective. They could not be regarded as economic activities within the meaning of the VAT Sixth Directive as they related to supplies made not in the course of ordinary business but in order to perpetrate a fraud and, consequently, fell outside the scope of VAT. B could not therefore have a legitimate expectation that its input tax claim would be met. (6) The refusal of B's claim in all the circumstances did not offend the principles of proportionality or of legal certainty, nor were any of its human rights infringed. (7) It followed that the appeal would be determined in the Commissioners favour and the assessment reduced from £5,267,799 to £5,171,183.Appeal dismissed.