Carousel fraud: UK regulator was wrong, says European Court

Out-Law News | 12 Jan 2006 | 3:35 pm | 2 min. read

The European Court of Justice today rebuked a method used by the UK’s HM Customs & Excise in tackling a VAT scam known as carousel fraud. HMCE wrongly refused to grant VAT rebates to innocent third party companies caught up in the scam.

The ruling concerns the joint cases of UK firms Bond House Systems Ltd, Optigen Limited and Fulcrum Electronics Ltd (in liquidation) – all three of which had innocently found themselves in the middle of a Missing Trader Intra-Community (MTIC) VAT fraud.

MTIC VAT fraud, also known as carousel fraud, occurs where fraudsters obtain VAT registration to acquire goods such as chips and mobile phones VAT-free from other Member States. They then sell on the goods at VAT inclusive prices and disappear without paying over the VAT paid by their customers to the tax authorities.

The scam reportedly costs the UK over £1 billion per year.

Recently, authorities have taken action against the fraud by considering all the transactions in a chain of supply involving a missing trader or a hijacked VAT number and refusing to repay VAT to any company involved in that chain of supply.

According to Customs, when considered as a whole, the transactions, even involving innocent parties, are a non-economic activity for VAT purposes and no rebates are necessary.

This approach was upheld by VAT and Duties Tribunals in cases brought by Bond House Systems Ltd, Optigen Limited and Fulcrum Electronics Ltd. All three firms appealed to the High Court, which subsequently made a combined referral to the European Court of Justice on the question of whether the three companies were carrying out an economic activity when they unwittingly became involved in the fraud.

Today, the European Court of Justice ruled that such firms are carrying out an economic activity, and as such are entitled to a VAT rebate worth, in Bond House’s case alone, £13.2 million.

The ruling follows the approach taken in an advisory Opinion to the Court by Advocate General Poiares Maduro in February last year.

The Court stressed that the Sixth VAT Directive assigns a very wide scope to VAT and to the key terms ‘taxable person’, ‘supply of goods’ and ‘economic activities’, reiterating that these terms are objective in nature and apply without regard to the purpose or result of the transactions concerned.

According to the Court, it would be contrary to EU law for tax authorities to take account of the intention of a trader, other than the taxable person concerned, involved in the same chain of supply, and/or the possible fraudulent nature of another transaction in the chain, of which that taxable person had no knowledge and had no means of knowledge.

In such a chain, each transaction must be regarded on its merits and the character of a particular transaction in the chain cannot be altered by earlier or subsequent events.

It follows, said the Court, “that transactions such as those at issue in the main proceedings, which are not themselves vitiated by VAT fraud, constitute supplies of goods or services effected by a taxable person acting as such and an economic activity.”

“The right to deduct input VAT of a taxable person who carries out such transactions cannot be affected by the fact that in the chain of supply of which those transactions form part another prior or subsequent transaction is vitiated by VAT fraud, without that taxable person knowing or having any means of knowing,” it added.

David Sweeting, Head of VAT Consultancy at accountancy firm Bentley Jennison, which acts for Bond House Systems, welcomed the ruling.

“This landmark decision will affect hundreds of businesses across the UK, as well as all those overseas companies that have traded with the UK and suffered the effects of this unjust law,” he said. “The decision gives industry more confidence in the judicial system because a sweeping injustice on a massive scale has been righted.”