[2011] UKFTT 217 (TC)

TC01082

Appeal number: MAN/08/0055

VAT – MTIC – contra-trading – clean chain broker – knew or should have known? – yes - appeal dismissed.

FIRST-TIER TRIBUNAL

TAX 

	TOTEL DISTRIBUTION LTD	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

				TRIBUNAL: Judge Richard Barlow
						Rayna Dean FCA
						Peter Whitehead

Sitting in public in Manchester on 7, 8, 9, 12, 13, 16, 19, 20, 21 and 22 July 2010 and 15 September 2010 (plus subsequent written submissions).

Ms Vivienne Tanchel for the Appellant instructed by Aegis Tax LLP

Mr Jeremy Benson QC and Mr Jonathan Cannan instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2011

DECISION

1.	In this appeal Totel Distribution Ltd appeals against the respondents’ refusal to allow input tax claims made by it in respect of the prescribed accounting periods consisting of the one calendar month-long periods April, May and June 2006 which we will refer to as 04/06, 05/06 and 07/06.  The sums in dispute are £1,130,503 for 04/06, £793,992.51 for 05/06 and £947,165.63 for 06/06 making a total of £2,871,661.14.
2.	The reason for the refusal to allow that input tax is that the respondents contend that it arose from transactions which were connected with the fraudulent evasion of VAT and that the appellant either knew or should have known of that connection with the consequence that, following authority to which we will refer, the input tax claim that might otherwise have been payable was properly refused.  The case is therefore what is termed a Missing Trader Intra-Community case (“MTIC case”).  
3.	This particular appeal relates to what is called contra-trading which means that the respondents allege that, although the appellant’s transactions were not themselves directly part of a chain of transactions in which there was a fraudulent tax loss, those transactions were connected with other chains of transactions in which there was a fraudulent tax loss and that the appellant’s transactions had lent assistance to the fraud in those other chains.  
4.	In brief, the allegation is that the suppliers of the goods to the appellant had input tax claims which arose in the course of those suppliers’ involvement in fraudulent chains of transactions.  In those fraudulent chains other traders had failed to account for output tax so that when the appellant’s suppliers claimed their input tax, having made zero-rated onward supplies of goods, that input tax gave rise to a payment by HMRC which was not countered by a payment of output tax elsewhere in the chain; thus making a fraudulent profit for those involved in the fraudulent chain of transactions.  The alleged purpose of the appellant’s suppliers in making the supplies of goods to the appellant was that the transactions in which the appellant bought goods from those suppliers created output tax liabilities which offset and therefore disguised the existence of the fraudulently claimed input tax, making it less likely the respondents would make inquiries; because the suppliers’ tax returns would not appear to consist of a large repayment claim or at least the size of the claim would be reduced.  
5.	Assuming the respondents’ allegations are proved, the appellant’s suppliers are what are known as contra-traders.  That is a term coined by the respondents and we will use it for convenience but it should not be overlooked that what is in issue is whether the appellant’s transactions were connected with fraud in the relevant sense and that labelling its counterparties in one way or another will in no way assist in proving that connection.  Similarly it has become common, for convenience, to refer to a chain of transactions in which there is no actual fraudulent loss (eg the chains of which the appellant’s transactions form part) as a “clean chain” which is something of a misnomer, if the respondents’ allegations that it was entered into for fraudulent reasons are correct; whether or not that was know to the appellant.  Similarly a chain of transactions in which a fraud has occurred is called a “dirty chain” which also risks obscuring that fact that the existence of the fraud requires to be proved if disputed.
6.	It would be better if the terminology were to be “the apparently clean chain” on the one hand and the “allegedly dirty chain” on the other, at least until the Tribunal has made the necessary findings, but the terminology has become so ubiquitous that we will adopt it but with the caveat that we should not be taken to have pre-judged any of the issues in the case by doing so.
7.	We would like to thank all three counsel and their solicitors for the presentation of this case.  The papers were extremely well prepared and the case was conducted very efficiently.  We would particularly like to express our appreciation for the clarity and intellectual rigour with which Ms Tanchel presented the appellant’s case. 
8.	The legal principles applicable to this appeal are well established by authority and we need not set them out in detail.  The principles applicable to such cases are contained mainly in the cases of Kittel –v- Belgium [2008] STC 1537, and Mobilx –v- HMRC [2010] EWCA Civ 517.  In view of the concessions made by the appellant (see below [21]) the only issue is one of fact.    
9.	If the Commissioners prove that a taxpayer’s transaction was connected with fraud and that the taxpayer either knew or ought to have known that it was connected with fraud that taxpayer will lose the right to recover input tax which would otherwise be recoverable. 
10.	We were invited to take account of the Tribunal’s findings about the grey market which were made in a different appeal.  We agree with the respondents that that would not be appropriate as a matter of law because one Tribunal cannot bind another on questions of fact unless two cases are heard together.  We would however add that the fact that the appellant’s transactions are in a grey market did not advance the commissioners’ case against the appellant in any way.  The evidence did not prove to our satisfaction exactly what the size of the grey market in the goods in question was at the relevant time.  Although the evidence about the grey market might have been relevant to issues about whether the transactions in the dirty chains were fraudulent, on the basis that the transactions constituted a suspiciously large part of that market or even exceeded its size, the fact that those transactions were conceded to be fraudulent, as we will mention later, made it unnecessary for us to decide those issues.  The evidence did not prove that the appellant knew what the size of the grey market was so the evidence about it was irrelevant to the remaining issues in the case.    
11.	The basic facts about the appellant’s transactions are not in dispute.
12.	 We refer later in this decision to a concession Ms Tanchel made on behalf of the appellant which has considerably narrowed the issues still in dispute and obviates the need for us to refer to a good deal of the respondents’ evidence much of which related to the issues no longer in dispute.
13.	It is sufficient to summarise the commissioners’ case by saying that their evidence about the chains of transactions was sufficient to show that the dirty chains leading to the broker in those chains were fraudulent and that the clean chain transactions were connected with that fraud; all of which is now conceded by the appellant.  The rest of the respondents’ evidence was provided to introduce the evidence, mainly in the form of documents, about the appellant’s transactions which we deal with below and which we have dealt with from the point of view of the appellant’s explanations and evidence.
14.	The commissioners’ case was that the appellant knew or at least ought to have known that its transactions were connected with fraud because of the nature of the transactions.  That knowledge or the fact that it ought to have been known to the appellant is a matter for inference based on all the circumstances of the transactions and the commissioners’ case was that the inference should be drawn from all the evidence about the nature of the transactions and how they were carried out. 
15.	The appeal relates to thirteen transactions in period 04/06 in which the appellant bought and sold iPods (six transactions) and mobile phones (seven transactions).  The invoice dates for the purchases of all thirteen transactions by the appellant were 26, 27 or 28 April 2006 and the invoice dates for its onward sales were 28 April in nine cases, 23 April in one case (though that must have been in error as the invoice for its purchase was 26 April), 26 April in one case and 3 May in two cases.  The 3 May sales should have been included in the May return if that date is correct but nothing turns on that.
16.	The appellant’s suppliers were Morganrise Limited (‘Morganrise’) (six deals), Prime Telecom (UK) Ltd (‘Prime’) (two deals) and Demravale Telecommunications Ltd (‘Demravale’) (five deals).  They were all UK registered companies.  All the goods sourced from Morganrise were sold to African Network BV (‘African’) (a Netherlands company).  One parcel sourced from Prime was sold to FAF International Srl (‘FAF’) (an Italian company) and the other was sold to Kiara Trading International Sarl (‘Kiara’) (a French company).  Three parcels of goods sourced from Demravale were sold to Pro Choice Commercial (‘Pro Choice’) (a Portuguese company) and two to Racheltel Slu (‘Racheltel’) (a Belgian company).  
17.	The appeal relates to 7 transactions in period 05/06.  Four parcels were obtained from K&M and were sold to African.  The other three were obtained from Prime two of which were sold to Kiara and the seventh was sold to Phone Connected Sarl (‘Phone Connected’) (a French company).
18.	The June deals numbered six of which Demravale supplied four, all of which were sold by the appellant to Euro Safety Net BV (‘Euro Safety’) (a Dutch company), and Prime supplied two which the appellant sold to FAF.
19.	The price of all the appellant’s purchases included VAT as they were sales of goods from UK companies to a UK company.  It is not in dispute that the UK suppliers accounted for output tax.  The appellant’s sales were all dispatches to other EU countries and were therefore zero-rated giving rise, in principle, to a recovery of input tax by the appellant on the purchases without there being any output tax payable on its sales.    
20.	The appellant’s gross profit on those sales in the three month period was £1,142,084.50 and it made a book profit on every one of the deals involved in the appeal.  The realisation of the cash profit on every deal would however depend upon the recovery of input tax because the sale prices achieved on the zero rated sales were always less than the tax inclusive price paid to the UK suppliers.  The profits were generally in the range 4.5% to 6.0% but the Morganrise April deals 1-6 which were iPods achieved 10.65% and the K&M May deals 1-4 which were car kits achieved 13%.
21.	Ms Tanchel conceded the following points in her written closing submissions:
That the Commissioners can prove:
(a)	that there were tax losses in the broker chains of the alleged contra-traders,
(b)	that the losses resulted from fraudulent evasion,
(c)	that the appellant’s transactions, the subject of this appeal were (following the reasoning of the Chancellor between paragraphs 40 and 46 in Blue Sphere) “connected” with that evasion.
She added that the sole issue for the Tribunal is therefore whether at the time of entering into those transactions the appellant knew or ought to have known that the transactions were connected with the fraudulent evasion of VAT.
22.	Those concessions were rightly made but we would like to add that Ms Tanchel was perfectly entitled to put the Commissioners to proof of some aspects of their case dealing with those issues (some were conceded at the outset) and the concession she later made, though inevitable after the evidence had been tested, in no way suggests that she could be criticised for taking the points she did initially take issue with.   
23.	We therefore turn to the evidence about the issue which remains in dispute which is whether the appellant knew or ought to have known that its transactions were connected with fraud.
24.	The appellant’s evidence consisted of that of its director Mr Keith Rowbotham and Mr Barry Neilson.  We will deal with the evidence of Mr Neilson first.
25.	The truthfulness of Mr Neilson’s evidence was not challenged.  He gave evidence about work he had done on behalf of the appellant in carrying out due diligence enquiries on its behalf.  He made enquiries about all four of the suppliers relevant to this appeal, namely Morganrise, Prime, Demravale and K&M.  He also enquired about three of the seven relevant customers namely African Networks, Pro Choice and Euro Safety and three Freight Forwarder/Storage companies namely United Express, P&D and Tecsmart.
26.	Mr Neilson had been a salesman for various companies in his early years and later developed a very successful company which provided a record storage system originally for solicitors and later for businesses generally.  After that business was bought from him for a considerable sum he traded in mobile phones until he decided that was too risky a business for him to engage in and latterly he had provided the service of enquiring about due diligence on behalf of the appellant and Totel Ltd.  Totel Ltd is a separate company from the appellant and although there are some factual connections between Totel Ltd and the appellant they are not connected in any technical legal sense.
27.	Mr Neilson claimed to be able to use his business expertise to weigh up people whom he met in the course of making due diligence enquiries and it appears he relied on that expertise sometimes in the absence of objective proof of the correctness of his opinions.  He made it clear that the focus of his attention when he made the enquiries was whether he thought it likely that the subject of the enquiry would become a missing trader and he made the point that at the time of the enquiries he had no knowledge of the concept of contra-trading; which we find was the case as it was also given in evidence that at that time HMRC had not really understood how contra- trading operated and certainly had not publicised the phenomenon.
28.	Dealing with the specific enquiries he made we make the following findings which are the uncontested facts as Mr Neilson stated them to be in his witness statement and his oral evidence.
29.	We will deal first with his evidence concerning the appellant’s suppliers.
30.	So far as Morganrise was concerned Mr Neilson formed the view that the company had a prestigious and busy office.  He saw trade references and the director of that company was able to prove to him that he had been resident at his home address for ten years.  No-one objected to Mr Neilson taking photographs and a possible discrepancy about which suite of offices Morganrise occupied did not come to his attention.  We note that some documents refer to suite 202 and some to suite 203 but we regard that as of no relevance as the company may have occupied both suites and even if there was a mistake on some of the papers it would be most unlikely to have led to any real consequences because of the proximity of the addresses within the same building.  We also note that the photographic evidence showed that the company operated from serviced offices, a fact that Mr Neilson failed to appreciate.
31.	That due diligence enquiry would have been of some considerable benefit to anyone thinking of dealing with Morganrise but in the context of this case we find that that enquiry was not really helpful to the appellant because Mr Neilson agreed with Mr Benson QC that documents showed that his visit had been after 10 May 2006.  That was after all the six deals between the appellant and Morganrise in which the appellant bought goods worth £1,595,966.30 (tax inclusive) on 28 April 2006 and committed itself to paying that sum to Morganrise.
32.	Mr Neilson had not kept any documents relating to his enquiries about Prime and so was unable to give any evidence about the due diligence enquiry concerning that company except that he remembered he had visited it.
33.	Mr Neilson visited Demravale and obtained details of the company, he observed that it appeared to be a genuine business with 12 or so employees and obtained photographs of the director and confirmation of his identity.  The documents show that this was carried out before any of the deals in this appeal and Mr Neilson concluded that there was no reason to think that Demravale would become a missing trader.  We find that to be a reasonable conclusion and that he reported that conclusion and passed that information on to the appellant before the deals in question took place.  We note however, that Mr Neilson’s conclusion was that he thought Demravale would not go missing.  He did not have any basis for recommending whether that company was financially sound or otherwise suitable for the appellant to engage in business with it.  He did not think the company operated from serviced offices but he accepted that it was based on a business park.         
34.	Mr Neilson’s enquiries of K&M led him to the conclusion that the company was in a reasonably large way of business.  It had cooperated by producing evidence of identity for its director.  We note that although it had only started trading in February 2006 it claimed in its introductory letter to have had “many years of experience in the industry”.  The licence agreement for the occupation of K&M’s business premises lasted for less than two months after the date of Mr Neilson’s business but he did not appreciate the relevance of that.  Mr Neilson accepted in his witness statement that his visit to K&M post-dated the appellant’s four deals with that company in which the appellant purchased goods valued at £2,683,934.90 (tax inclusive) and committed itself to pay that sum.
35.	Next we deal with Mr Neilson’s evidence about customers.
36.	Mr Neilson visited African Networks in the Netherlands.  He obtained documents in Dutch which were later translated as giving the date of incorporation and commencement of business as 1997.  He met a man whom he described as “a character” in a café and took some photographs of the impressive looking outside of a building said to be the company’s office but he was refused entry on the pretext of its office being redecorated.  He never received the promised proof of identity of “the character”.  Mr Neilson reported back to the appellant that he thought African Networks was a “dodgy” (his word) company and that he recommended the appellant should not deal with it until the proof of identity was obtained.  The appellant had already dealt with African Networks by agreeing to sell to it some of the goods referred to in [16] above before Mr Neilson’s visit and some of those referred to in [17] above after his visit but before he reported his findings.  
37.	Thus the appellant had bought and sold goods worth £4,279,901.20 without receiving Mr Neilson’s due diligence reports for either of its counterparties in those deals; being Morganrise and K&M as suppliers and African Networks as purchaser.
38.	Mr Neilson met a Mr Foy who was a director of ProChoice.  He met Mr Foy in the UK though the company was incorporated in Portugal and was based in Madeira.  Mr Neilson did not discover that Madeira was not on the Portuguese mainland; though that would have been a relevant point as it could materially affect the transport arrangements the appellant would need to make in the event that a transaction occurred between them.  Mr Foy lived in Spain but Mr Neilson did not make enquiries about how that affected the operation of ProChoice.  Mr Foy produced limited information in Portuguese and a passport photograph of himself.  He produced photographs of what he said was the outside of the company’s offices and an interior shot of an office with an empty desk both of which Mr Neilson agreed when cross- examined could have been anywhere.  Mr Neilson did not say when he met Mr Foy but the documents referred to were received from Mr Foy on 5 May 2006, after the appellant’s deals with ProChoice in which goods worth £2,146,650 (zero rated) had been sold to that company.
39.	Mr Neilson visited Euro Safety on the same visit to the Netherlands as the one on which he visited African Networks.  That was before the appellant’s deals with Euro Safety.  The due diligence documents produced were extensive though they were mostly in Dutch.  The company’s director cooperated with Mr Neilson’s enquiry and afforded him access to the company’s premises and provided proof of identity.  Mr Neilson formed the view that the company was properly run and in a reasonably substantial way of business and we agree that there was a basis for that conclusion.  We do not agree with the respondents that it mattered very much that the director lived in Belgium rather than the Netherlands as we were not told how far from the border the Euro Safety premises were or how far from it the director lived.              
40.	Mr Neilson verified the existence of the premises of three Freight Forwarder or storage companies namely P&D, Tecsmart and United Express.  His enquiries were mostly limited to considering the premises themselves and, for example in respect of United Express, he obtained limited information because the director was on holiday.  Mr Neilson was shown photographs of the United Express premises which were in a converted castle or at least had a castellated wall and he stated they were in a remote location at the end of a half mile single track road on the top of a hill in North Wales.   
41.	The only other witness for the appellant was Mr Rowbotham and, naturally, he was the main witness.
42.	Much of Mr Rowbotham’s evidence consisted of describing his way of operating the appellant’s business and referring to documents relating to the transactions under appeal.  Our decision is largely based on our analysis of the transactions and the way they were conducted and the inferences to be drawn from that evidence.  There was a major disagreement between the parties about what inferences should be drawn from the way the business was operated and in particular the divergence between what the documents appeared to show was the nature of the transactions and what Mr Rowbotham said was the form they actually took.      
43.	Mr Rowbotham described his experience in business.  He had worked for the Mirror Group of newspapers and had risen to the senior post of deputy general manager of its Northern Office managing the printing and distribution of its papers and magazines in the North of England and administering the organisation including the management of considerable budgets.  He accepted redundancy on favourable terms in 1995 and spent some time organising corporate hospitality and then started a company (MTS Ltd) whose business was dealing in mobile phones which that company bought from authorised distributors and held as stock and sold in relatively small numbers to retailers.  That company operated from the same premises as Totel Ltd but it failed following two thefts of uninsured stock from its premises.  Mr Rowbotham then spent some time dealing with sales of mobile phones for Totel Ltd on a commission basis.
44.	Mr Rowbotham presented himself to us as a successful man who had achieved much in three different spheres of life (the management of a large company, arranging corporate hospitality and dealing in telephones).  Having observed him giving evidence over more than three days, much of that being under cross-examination by a Queen’s Counsel, we find him to be an intelligent man and he struck us as being by no means naïve in business life.                        
45.	The appellant company was founded in 2001 with a view to dealing in the wholesale market in mobile phones and Mr Rowbotham chose the name Totel Distribution Ltd with a view to benefitting from a supposed association with the Totel companies, though Mr Rowbotham insisted that there was no actual association.  The respondents contended that there was an association with Totel Ltd and that the appellant may not actually have been genuinely trading on its own account at all.  
46.	Two particular issues emerged in that respect.  First was the somewhat unusual fact that, although the two companies were clearly operating in the same competitive field, Totel Ltd allowed one of its staff to work for the appellant as well as for itself so that that member of staff knew about both companies’ trade secrets.  Mr Rowbotham accepted that that fact had caused confusion on occasions and that some of the paperwork for Totel Distribution Ltd’s transactions was wrongly addressed to Totel Ltd but he insisted that the transactions in question were indeed the appellant’s transactions.  In particular he relied upon the fact that Totel Ltd was in a bigger way of business (or we would say an even bigger way of business) than the appellant.
47.	  There was also evidence that a large payment (£450,000) from Totel Distribution Ltd to Totel Ltd had been described as a loan on some of the bank documents whereas Mr Rowbotham said it was payment for a failed transaction that the two companies had intended to undertake.  In any event, it was paid back to Totel Distribution Ltd a good time after the original payment and Totel Ltd appears to have used the money for its own business in the meantime without paying any interest.  Mr Rowbotham did not explain how a business as reliant on cash as the appellant could afford to be without such a large sum for such a long period or why no effective steps were taken to recover the money immediately after the deal in question fell through.
48.	However, we find that the evidence, although it does show that there was an unusual relationship between the two companies, falls short of proving that the transactions with which this appeal are concerned were in fact carried out by Totel Ltd.          
49.	Mr Rowbotham said in his second witness statement that in some cases the appellant’s due diligence enquiries “would have begun before the deals were done but not completed until after the deals were concluded”.  He appears therefore to admit that there were deals where no due diligence was done before the deals were done and it is certainly the case that on his own admission he paid little if any attention to the credit ratings or other indications of the financial strength of the appellant’s counterparties relying almost entirely on the benefits of dealing on ship on hold terms, which we will deal with below.
50.	Like Mr Neilson, Mr Rowbotham said that he thought the important thing was to make sure the counterparties were real organisations.  He said: “I thought, well at least if I do proper due diligence on people and visits and so on and meet them, at least I’ll be able to put a face to a name and I’ll know where they operate from, I’ll know which house they live at, I’ll know their passports.  So, my thinking was, if I can find people like that then at least I’ve got a good chance that those people are not these mystery people that nobody ever seems to have met and just disappear with the money”.  Later he said: “I found that that [Dunn and Bradstreet] credit check was really a waste of money because obviously that doesn’t reflect on the people they purchased from but I was hoping to put myself in a position whereby I didn’t need to risk my money on a deal if I could get them imported, I would ship on hold”.
51.	The reference to “if I could get them imported” in the last passage quoted reflects Mr Rowbotham’s stated belief that as long as he bought goods from importers he could be sure they would not be defaulting traders and it is true that the transactions in this appeal are purchases from importers and in one case, after he found out that a company (which does not feature in this case) was not an importer; he entered into no further deals with it.
52.	However, the evidence given by Mr Rowbotham about any additional due diligence he might have carried out before the transactions in the cases where Mr Neilson did not visit the counterparties until after the transactions had occurred or at least begun, was generally very limited and amounted to little more than assertions that he had met the people concerned, rather than that he had made any actual enquiries about them.          
53.	We bear in mind what Moses LJ said in Mobilx about the limited relevance of due diligence and we consider the actual features of the transactions and the way they were carried out is much the more relevant evidence in this appeal.  Nonetheless, we cannot but find it significant that Mr Rowbotham traded with several of his company’s counterparties before receiving the due diligence reports on them.  We find that indicates that the due diligence was obtained mainly for the sake of appearance and not as a safety measure for the appellant.  That is a strong indication that Mr Rowbotham knew that he could safely deal with those parties despite apparently knowing very little about them which is in itself an indication that the deals were contrived and that the contrivance was something of which he must have been aware. 
54.	Mr Rowbotham described his business model in the following way in his second witness statement and in his oral evidence.  He proposed the appellant would deal in larger volumes and values than he had been involved with before in MTS Ltd and to deal only with goods sold to it by importers. The appellant would then sell the goods to buyers in other countries.  The deals were to be “back to back” by which he meant that the appellant would only pay its supplier when it had been paid by its customer.  He envisaged that the sale prices would be lower than the tax inclusive purchase prices so that only the tax would have to be financed by the appellant which means that the appellant would have to be able to bear the difference in price until the recovery of input tax.  In fact the difference in price would largely consist of the input tax though we assume Mr Rowbotham realised that it would be the input tax less the appellant’s profit on the deal that would have to be financed.  
55.	The actual mechanics of the deals that this appeal is concerned with were said, by Mr Rowbotham, to be as follows.  The goods were at a freight forwarder’s premises or storage warehouse in the UK after they had been imported.  Mr Rowbotham negotiated with the seller and the buyer to arrive at prices and when the deal had been agreed in principle he instructed the Freight Forwarder or Warehousekeeper to inspect the goods.  Once that had been done and he was satisfied the goods met the description given by the seller and that ordered by the buyer the goods were shipped “on hold” at the appellant’s expense to another Freight Forwarder’s premises or warehouse abroad nominated by the buyer.  The goods were on hold until the appellant was paid for the goods.  The buyer would pay the agreed price only after it had satisfied itself that the goods were as described at which time the appellant would pay the supplier.  Ownership of the goods would then pass from the seller to the appellant and on to the buyer.  
56.	Mr Rowbotham had only a poor understanding of the concepts of possession and title to goods and of the difference between those concepts.     
57.	The method of trading adopted by the appellant involves risks.  Mr Rowbotham said that the agreement with the seller was also on “ship on hold” terms so that if the deal fell through for some reason the appellant was only at risk so far as the transport costs and the cost of inspection before shipping were concerned.  If the deal fell through the goods would simply be recovered and returned to the seller who would remain the owner of the goods.
58.	However, on the evidence we heard, the risks appeared to be very much greater than that.  The appellant’s due diligence on its purchasers was very limited, as we have already found to be the case and in particular it generally did not concentrate on the financial standing of the purchasers at all.  The appellant made no due diligence enquiries about the purchasers’ Freight Forwarders or Warehouse-keepers.  There were therefore multiple risks inherent in sending abroad goods worth very substantial sums. The appellant had not paid its suppliers and it would have a potential liability to them if the goods went astray.  The goods were sent to customers who were entities about which the appellant knew little.  The goods were delivered into the custody of entities about which the appellant really knew nothing but on whom it would have to rely to keep the goods safe until the customers paid for the goods and to release them to the customers only after the appellant had given proper authorisation.     
59.	The fact that the agreements were on ship on hold terms, even if that is the case, by no means removes the risk that either the buyer or its Freight Forwarder could turn out to be dishonest or insolvent and would simply abscond with the goods or fail to pay for them. 
60.	 The method of trading as described by Mr Rowbotham was also at odds with the paperwork in many of the transactions.  By paperwork we mean such documents as stock offers, stock allocations, freight movement documentation and invoices.  Despite the size of the sums in question and despite the absence of any history of dealing with its counterparties the appellant relied, and so indeed did the counterparties, on the scantiest paperwork where it might have been expected that properly drafted legally enforceable agreements would have been needed.  Where contractual terms were specified in such documents as were drawn up they were often allegedly overridden by oral agreements which were themselves not recorded.  No record was kept of telephone conversations which Mr Rowbotham claimed gave rise to such agreements.
61.	Many of the documents, as well as not accurately reflecting what the appellant had agreed with its counterparties, were not provided until after the relevant party had parted with possession of the goods.  Freight movement documentation showed impossibly short journey times.     
62.	By way of example of the above points we will refer to some specific documents.
63.	Morganrise issued invoices which stated where the goods were located in the form “goods to be released and to be located at” followed by the address of United Express in North Wales and stated the payment terms to be “full payment after the inspection of the goods”.  That document does not explain in what circumstances the goods were to be released or what the inspection was to consist of and “after inspection” is at best ambiguous as it could mean payment fell due as soon as inspection had occurred or it could mean simply at some unspecified time later than the inspection.  
64.	Offers of stock and an allocation of stock form were faxed to the appellant at the same time for each of the individual Morganrise deals and those forms for all six of the deals were faxed within minutes of each other.  The offer of stock stated that if the appellant was interested in buying the stock it should inform Morganrise as soon as possible but the accompanying allocation of stock form said “the … goods have now been released and ready for collection”.  The goods had therefore been offered and released without Morganrise waiting for confirmation that the appellant wanted the goods and were released without the appellant having agreed that it had inspected them; at least so far as the documents recording the transaction showed.
65.	 Morganrise gave no proof that they actually owned the goods and Mr Rowbotham’s evidence was that so far as he was concerned, as they were in Morganrise’s possession, he was satisfied on that point.  We have already found it to be the case that the appellant dealt with Morganrise before receiving Mr Neilson’s due diligence so in effect he was dealing with a company of which he knew little.
66.	Morganrise released the goods to the appellant without having received payment and apparently contrary to its own terms.  Those terms were inadequate at best, given the value of the goods and, as we have found, were only the few ambiguous words on the invoice.
67.	While referring to the Morganrise deals we also find that the goods cannot have been physically dealt with in the way the documents suggest.  The faxes releasing the goods were timed between 15.39 and 15.45.  The goods were at storage premises near Abergele, North Wales and the appellant did not dispute that that was at least 316 miles from the Channel Tunnel yet most of them were checked in at the Tunnel by 18.19 which we find to be an impossibly short time by a wide margin.
68.	Mr Rowbotham accepted in evidence that the goods must have left the storage premises before he had sent the written instructions as to where they should go but he added “I would have given them verbal instructions.  Everything is verbal to start with and then it’s followed up at a later – not always time critical – at a later time”.  
69.	Even if the appellant and Morganrise had had a history of dealing with each other on specific terms it might have seemed odd that the paperwork was so scanty and it would have been inexplicable that the goods left the storage premises before the parties had agreed to sell and buy.  But for deals of this value to be done in this way between parties who barely knew anything about each other is so extraordinary that it leads to the conclusion that the deals could not be what they appear to be.  That is our conclusion and we find that the deals were not straightforward purchases and sales between parties dealing on normal commercial terms.  Rather we find that the deals must have been based on some understandings between the parties which have not been expressed in the documents.  Nor have we been told how those understandings arose. We will return to this point later in the decision.  
70.	Prime’s invoices to the appellant said payment was “due on receipt” but Mr Rowbotham stated in evidence: “I assumed they were happy with the terms I had agreed with them”.  Prime released the goods to the appellant before payment but the appellant was not prepared to release the goods to its customer until payment.  Mr Rowbotham said that it was understood between him and Prime that the terms would be short term credit which was why it was his responsibility to chase up his customers.  We find it surprising that such a variation of the terms specified on the invoice was agreed orally without at least a memorandum being made by the appellant to record the variation, if that is what he meant had happened.  In fact what Mr Rowbotham said was that it was “understood” those were the terms and during his evidence he repeatedly referred to understandings which it appeared had come about not as a result of specific agreements, even oral agreements, but rather simply because everyone concerned knew that was what would happen.  Even if we accept that there was an oral agreement or some generally understood arrangement it is even more surprising that for deals of the size and number involved in this case the vendor would deal on terms that the purchaser would just be left to endeavour to secure the payment as soon as possible with an open ended credit being informally allowed.
71.	Demravale’s invoice stated “amount due in full” and “goods released on full payment only”.  Despite that, the goods were shipped to Pro-Choice, the appellant’s customer, before payment was made to Demravale.  Indeed, contrary to the appellant’s terms as described by Mr Rowbotham, Pro-Choice then sold some of the goods on to its customer (VPA) before it had paid for them though it seems possible that Pro-Choice did not actually release the goods until its customer paid.  Demravale were not paid until at least 19 days after they had released the goods.  This was a deal in which Demravale made a gross profit of £5,700 on an investment of £2,025,900 though we accept that Mr Rowbotham did not know those figures.
72.	K&M issued standard terms which were admittedly somewhat confusing because they stated goods remain the property of K&M until payment in one clause but also contained a clause stating the buyer shall be entitled to resell or use the goods in the ordinary course of its business.  Whatever K&M’s terms were, the appellant again dealt with the goods on entirely different terms which Mr Rowbotham said they understood because of a verbal agreement.
73.	We find that the appellant dealt with each of its suppliers on terms entirely different from those expressed in their documents and that despite the large sums involved and the lack of any prior trading history or any adequate knowledge of those suppliers the appellant was prepared to do so without even recording the terms that had been agreed orally.  The terms as allowed in practice were more rather than less favourable to the appellant than those expressed in the documents and so it might be said that it was not surprising that Mr Rowbotham was prepared to deal on those terms.  But given that the appellant was aware that the deals were supposed to be done “back to back” on “ship on hold” terms it must have been obvious to Mr Rowbotham that the suppliers’ willingness to extend credit to him and to risk losing control of the goods before payment was a very questionable fact.  
74.	The rationale of the market in which the appellant operated was supposed to be that there were opportunities to be taken from the daily or almost daily price fluctuations in a fast moving market.  It must also therefore have been obvious to Mr Rowbotham that his suppliers could not be reasonably expected to take the risk that their sales would fall through, if the appellant’s customers did not pay for the goods, on terms that the appellant was then entitled to return the goods and cancel the deal without any penalty; which is what Mr Rowbotham claims was agreed.  The length of time before payment was received referred to in [71] above is also at variance with the stated market rationale or business model described by Mr Rowbotham as that adopted by the appellant.
75.	When pressed, Mr Rowbotham said concerning the possibility that he would have to return goods if his customer did not pay him: “I suppose it’s like any contract.  It’s breakable isn’t it.  But I would be morally obliged to find another buyer for the goods like I have done in the past”.  That answer was entirely inconsistent with his statements that the parties had agreed that the goods could be returned if the customers did not pay.  Even if the agreement was that the goods could be returned there was a serious risk that the purchasers, about which very little was known, would simply abscond with the goods.  Given the value of the goods, even if that risk was small, it is surprising that the appellant was prepare to deal with buyers without making full enquiries about them and their Freight Forwarders.  Mr Rowbotham also said that the vendors always knew and agreed to the destination of the goods.  It is even more surprising that they were prepared to relinquish control of the goods before payment and contrary to their normal terms as expressed in their documents because if any buyer absconded with the goods they would risk losing very considerable sums.
76.	Nor did Mr Rowbotham have an answer to the question why, if the vendors knew the destination of the goods, they did not deal with the appellant’s customers directly and keep more of the total profit available within the chain of transactions for themselves.  
77.	Mr Rowbotham accepted that his company had been in a privileged position by being able to deal on ship on hold terms and on terms that it did not have to pay for the goods until it had been paid.  Apart from asserting that was how his business model worked he was unable to give what we regard as a satisfactory explanation of why he was allowed that privileged position. 
78.	Mr Rowbotham agreed when he was cross-examined that, although he felt he had succeeded in avoiding dealing with people who went missing, he had in fact dealt with fraudulent people.  He asserted that that conclusion was only with the benefit of hindsight.  We accept that some of the facts that show the other people involved in the transactions were involved with fraud were outside Mr Rowbotham’s knowledge.  An example is the low level of profits made by the people who sold goods to the appellant.  That was a fact that he did not know.  
79.	However, other facts known to Mr Rowbotham and therefore to the appellant are such that it should have been obvious that the transactions were connected with fraud.  We next set out some examples. 
80.	 It seems obvious that given that the appellant found its trading partners, both sellers and buyers, from the same readily accessible sources, those trading partners ought to have been able to find each other thus cutting the appellant out of the transaction and increasing their potential profit by 6% or thereabouts.        
81.	The goods also made an apparently unnecessary journey to and from the UK which allowed the appellant to make an approximately 6% gross profit with a relatively small employment of capital over a relatively short period.  Goods were stored at a facility 316 miles from the Channel Tunnel making the journey to and from the UK less efficient and more costly than might otherwise have been the case.
82.	The way in which the transactions were carried out on unrecorded verbal terms which contradicted the extraordinarily vague written terms was remarkable (at least) given the enormous value of the goods involved.  As with the question of trading with counterparties before due diligence was carried out, we find it significant that the appellant was prepared to deal on vague terms understood between the parties but not recorded, is evidence of contrivance and of the fact that the appellant, through Mr Rowbotham, must have been well aware of that contrivance.
83.	The fact that everyone involved appeared to know how the deals should be done despite the contradiction between the terms on which they were done and the written terms shows that there was a cadre of traders who understood how the system worked and it must have been obvious to Mr Rowbotham that the way these deals worked was fundamentally similar to the types of deals he claimed to have avoided from a desire to avoid becoming involved in fraudulent transactions.  
84.	Mr Rowbotham was asked at the end of his evidence for an explanation of how the appellant’s counterparties came to know what were the special terms on which they dealt with the appellant.  He then claimed that he spelled out to those counterparties what the terms were.  He had not given that explanation earlier in his evidence and we reject it.  We find that the parties knew how the transactions worked because they were in that cadre of traders who knew how the system worked.  The truthfulness of Mr Rowbotham’s evidence as a whole comes into question because of that untruthful assertion.             
85.	We find that those facts were objectively an indication that the transactions were connected with fraud.  That is the more so as it was well known at the time that fraud was a particular and common feature of the market in which the appellant claimed to be operating and that these transactions were very similar to those of the type known to Mr Rowbotham to be fraudulent.  We do not agree that the mere fact that he dealt with importers meant that he could be sure that these transactions were not connected with fraud. 
86.	Two fundamental questions arise from the transactions as they have been described to us.  First, is the question why so many traders were prepared to allow the appellant the privilege of making large profits in transactions which appear to have had no rational explanation?  Why did some of those traders bring the goods to the UK and sell them to the appellant then some other traders buy them from the appellant in the UK for export in such short periods when it would appear they could have avoided dealing with the appellant altogether and probably also to have avoided bringing the goods to the UK in the first place?  Secondly, why were all the relevant parties prepared to deal on such vague and inconsistent terms depending, as they did, on unrecorded allegedly oral variations to such written terms as they had or on understandings that were not even actually spelled out in the context of the individual transactions.  We find that the explanation is that the parties had prior knowledge of a scheme of trading and how it operated.
87.	Given that Mr Rowbotham was an experienced businessman and an intelligent person and given that we do not find his evidence was entirely truthful we also find that those facts and the points we have made about trading before receipt of due diligence and trading on terms different from those shown in the documents; all show that he subjectively knew that the transactions were connected with fraud not just that the objective characteristics of the transactions meant that he ought to have known that fact (though we do also find that was the case).    
88.	We therefore find that the appellant knew that its transactions were connected with fraud and so the appeal is dismissed and the respondents were entitled to refuse to give credit for the input tax in question.
89.	This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

RICHARD BARLOW

TRIBUNAL JUDGE
RELEASE DATE: 31 March 2011