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16 January 2009 | HMRC v Limewire Telecoms | Back to News List

Livewire judge hands traders "impenetrable shield" against HMRC
in landmark High Court ruling

The High Court delivered a hammer blow to HM Revenue & Customs (HMRC)
today in its long-running dispute with Livewire Telecoms.

In 2006, HMRC withheld a VAT reclaim from Livewire of just under £2.2
million on the unfounded basis that Livewire bought and sold goods which it
"knew or had the means to know" were connected to "missing trader" (aka
"carousel") fraud. Livewire vehemently denied this accusation and instructed
expert tax advisors Vantis Tax Ltd to appeal HMRC's decision in the VAT &
Duties Tribunal.

In January 2008, Livewire won its case, much to the delight of traders
throughout the country, with the Tribunal finding that it had acted entirely
honestly and had done nothing wrong. HMRC appealed to the High Court,
prompting today's decision. Malletts Solicitors, instructing Essex Court
Chambers and Vantis Tax, represented Livewire in its defence of the appeal.

In his judgement, which was handed down today, Mr Justice Lewison roundly
dismissed HMRC's appeal, finding that it "must fail". In so doing, he has
reset the test for “means of knowledge” in "missing" and "contra" trading
fraud cases and has restored the legal balance of power.

Comment
"Today's decision is a landmark victory for honest traders and will force
HMRC to rethink their tactics. From now on, they will have to prove the
fraud that they say has taken place and prove that the trader could or
should have known of that fraud.

It is no longer good enough for HMRC to simply assert that a trader had
the means to know of some nebulous "wider fraud". With effect from today,
HMRC must show that the trader had the means to know that his goods
were connected to the fraud committed by the alleged missing trader up the line or, in the case of alleged contra-trading, the acts of the contra-trader.
This will be an immense task for HMRC. If a trader has done all that is
reasonably practicable to guard against fraud, how is he supposed to know
that a trader may have gone missing in a completely different supply chain
or that an exporter down the line is corrupt?

The Court has made clear that a trader who has taken all reasonable
precautions to avoid being caught up in fraud has, to quote the Judge, an
"impenetrable shield" against any claim by HMRC that he had means of
knowledge. Flaws in due diligence are not necessarily fatal unless HMRC can
demonstrate a causative link to the failure, which is to say that the measure
would have given rise to knowledge. HMRC were forced to accept this fact in
Livewire.

In practical terms HMRC have got to prove that the alleged missing trader
or the contra-trader (the exporter in the dirty chain) committed a fraud AND
that the party caught up in the chain knew or had the means to know of one
of those two frauds. If, as in Livewire, HMRC fail to prove that the exporter
was engaged in fraud, he will be unable to make out a case on means of
knowledge.

The Livewire judgement endorses what we have been saying for years,
namely that HMRC have to prove that a fraud has actually taken place, by
reference to cogent evidence, not mere speculation, and then persuade a
Tribunal that a trader operating in the real world could have discovered that
fraud. The balance has now been restored between HMRC and the trader
with all repayment cases now being up for grabs.

This case also reiterates the critical importance of good due diligence, good
monitoring of that due diligence and genuinely expert professional advice
from an early stage from those who genuinely know what they are talking
about. The law is now settled and cases will be won and lost in future on the
basis of a forensic examination of the evidence rather than fancy legal
debate about European cases. A great deal of credit in this case should go
to Vantis Tax, whose expert analysis paved the way for this victory."

Background
In the simple or "straight" form of MTIC fraud, a UK trader imports high
value consumables such as phones and chips VAT-free from Europe and then
sells them on to traders in the UK with VAT on top. He is obliged to account
for the VAT he has received on his sales, but instead pockets it for himself
and goes missing. Meanwhile, an exporter down the chain sells the goods
back across the channel to Europe and seeks to reclaim the VAT from HMRC
that he has paid on his UK supplies but can not recover from his European
customer. That customer, will then sell the goods back to the original UK
importer, where the fraudulent cycle will happen all over again- hence the
term "carousel fraud".

The more complex and devious form of MTIC fraud, which was alleged in
the Livewire case, is known as "contra-trading". Here, the fraudsters set up
a "clean" transaction chain which is used to throw HMRC off the scent of a
separate, "dirty", chain, often involving different goods altogether. The key
to the fraud lies in the fact that the importer in the clean chain is the same
company as the exporter in the dirty chain. As a result, the exporter makes
no reclaim (because he is able to offset his input and output VAT) and slips
under the HMRC radar.

But what happens where, like Livewire, a trader buys goods which HMRC
claim have been used in MTIC fraud? In the European case of Kittel, the
European Court held that the tax man was entitled to withhold the VAT if
the trader "knew or had the means to know" that his transactions were
"connected to" the fraud. The problem has been that the ECJ did not explain
what this test meant in practice and begged such questions as “knowledge
of what fraud?”

For years, HMRC have claimed that knowledge of a wider scheme to defraud
is enough without going on to prove the fraud that they say exists. They have
also maintained that any flaw in a trader's due diligence should be fatal to a
reclaim. These assumptions have underpinned their controversial "extended verification" policy, which has crippled the industry and where traders are all
guilty as charged. However, the Court in Livewire dealt a killer blow to such
tactics, ruling that HMRC must identify one of two possible frauds (see
above).

In the absence of proof of at least one of those two frauds, the trader can
not have means of knowledge. Even then, HMRC must show that trader
should have known from the procedures that he undertook or could have
known from procedures which were reasonable for him to take that his
goods might be connected to one of the two frauds. This raises very
difficult questions of causation for HMRC and represents a significant
evidential burden on them.

16 January 2009

HMRC v Livewire
Telecoms

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