Fonecomp Ltd v HM Revenue and Customs

The right to deduct input VAT under Directive 2006/112 is fundamental, but it may be withheld where a trader knew or should have known that a purchase formed part of a transaction connected with fraudulent evasion of VAT. The Kittel principle does not impose strict liability. The fraud or default need not occur in the same linear chain of supply. A connection may exist through intersecting or branching transactions forming part of one scheme. HMRC need not prove that the trader’s transaction tangibly assisted the fraud. The trader need not know the fraud’s precise mechanics, provided the objective circumstances establish the requisite knowledge or means of knowledge.

Fonecomp appealed from the Upper Tribunal’s decision of December 2013, which upheld the First-tier Tribunal’s refusal of input VAT credits claimed on two July 2006 mobile-phone transactions. The First-tier Tribunal’s decision is reported at [2012] UKFTT 102 (TC).

Softlink later defaulted on VAT, while Klick operated a contra-trading scheme involving connected clean and dirty chains. Although Softlink and Klick had no direct transactions with Fonecomp, the tribunals found that Fonecomp’s purchases were connected with the fraud and that it should have known this. The appeal concerned whether the Kittel principle was confined to fraud or default within the same chain of supply, and what connection and knowledge were required.

1. Appeal dismissed. The Court of Appeal unanimously upheld the tribunals’ conclusion that Fonecomp had no entitlement to credit for the input VAT.
2. Scope of the Kittel principle. The fundamental nature of the right to deduct input VAT did not prevent its withdrawal where the right was relied on for fraudulent or abusive ends. Kittel and Recolta Recycling [2006] ECR I-6161 was expressed in terms wide enough to cover contra-trading. Neither Bonik EOOD v Direktor na Direktsia ‘Obzhalvane i upravlenie na izpalnenieto’, Case C-285/11 nor the other CJEU authorities imposed a requirement that the VAT default occur in the same chain of supply. A chain could be connected through branches or intersecting transactions. [2015] EWCA Civ 39 [21]-[29].
3. Connection. Whether a transaction was connected with fraudulent evasion was an objective factual question. The trader’s knowledge was irrelevant to establishing the connection. HMRC did not have to show that the transaction provided tangible assistance to the fraud or appeared in a particular VAT return. The findings that the same phones were traded close in time, that input and output VAT were offset, and that the acquisitions aided Klick’s sales were sufficient. [37]-[44].
4. Knowledge. The required knowledge was knowledge, actual or imputed, that the trader was participating in a transaction connected with fraudulent evasion of VAT. The trader did not need to know the identity of the defaulter, the precise connection, or the mechanics of the fraud. The Mobilx test was not to be over-refined: liability arose where the circumstances showed that the only reasonable explanation was a connection with fraud, rather than merely making fraud more likely than not. [45]-[54].
5. Application and disposal. The First-tier Tribunal’s findings supported the conclusion that Fonecomp should have known that its transactions were connected with VAT fraud. No question of law arose from its lack of knowledge of the specific mechanics. A preliminary reference was unnecessary because the relevant CJEU case law made the answers acte clair. The appeal was dismissed. [47]-[56].

• Court of Appeal (Civil Division). The appeal was dismissed unanimously on 3 February 2015: [2015] EWCA Civ 39.
• Upper Tribunal (Tax and Chancery Chamber). Sales J and Judge Berner upheld the First-tier Tribunal’s decision in December 2013. No citation for that decision was stated.
• First-tier Tribunal. The tribunal refused the claimed input VAT credits and found that Fonecomp should have known that its purchases were connected with fraudulent evasion of VAT: [2012] UKFTT 102 (TC).