Pharmaquim Ltd v Revenue & Customs [2010] UKFTT 279 (TC) (11 June 2010)

DECISION

Introduction

1. In 2005 and the first six months of 2006, the appellant company, Pharmaquim Ltd., which until 10 May 2006 was called Cormila Ltd (but to which, for convenience, we shall throughout refer as “Pharmaquim”), traded as a wholesaler of mobile phones. For accounting periods 03/06 and 06/06, it made VAT input tax repayment claims based on zero-rated supplies to traders in the EU. Initially, the Commissioners accepted its claim of £1,883,615.93 for the earlier period and, on 20 June 2006, repaid Pharmaquim the full amount thereof. However, they subjected the later return to extended verification to ascertain whether any or all of its export transactions traced back to a tax loss. They found every transaction so to do. Consequently, by letter of 1 March 2007, they denied Pharmaquim’s entitlement to input tax recovery of £3,590,548.50. The Commissioners disclosed their reason for denying the claim as that the company “either deliberately, or recklessly, ignored factors which indicated that [its] transactions may have formed part of …an overall scheme to [defraud the revenue]”.

2. On 19 March 2007, Pharmaquim appealed the decision, giving its reason for appealing as:

“HMRC have wrongly denied the right to reclaim input tax amounting to £3,590,548.50 on the basis that the company knew or should have known of fraud in its supply chain. The company had no such knowledge and has taken every reasonable precaution to ensure that its transactions are not connected with fraud. It is therefore entitled to rely on the legality of its transactions under community law.”

3. Subsequent to the decision of 1 March 2007, the Commissioners discovered a further transaction of Pharmaquim in period 06/06 which they traced back to a tax loss. They also found that they had erroneously attributed to period 06/06 an input tax claim properly attributable to period 03/06. Consequently, on 25 February 2008, they issued two further letters to Pharmaquim, the one increasing the input tax denied in period 06/06 to £3,678,923, and the other assessing the company to tax of £269,500 for period 03/06, the latter sum having been included in the 03/06 repayment. In the letters the Commissioners stated that in making their decision they relied upon the principles expounded by the Court of Justice of the European Communities (“the ECJ”) in Kittel v Belgium and Belgium v Recolta Recycling SPRL (Joined Cases C-439/04 and C-440/04) [2008]STC 1537. Shortly stated, those principles are that a trader who has participated in a fraudulent scheme involving the purchase and sale of goods, knowing or having the means of knowing that he is so participating, forfeits the right to deduct the input tax incurred in his purchase of the goods used as the vehicle of the fraud.

4. Following the issue of the February 2008 letters, Pharmaquim’s appeal was, and continues to be, treated as against both denial of the claim for period 06/06 and the assessment for period 03/06.

5. In the statement of case, the Commissioners allege that the facts of the case support the conclusion that Pharmaquim’s due diligence checks were casually undertaken and it ignored negative indicators “because they were, in truth, unnecessary; the appellant knew perfectly well that its suppliers and customers would not fail in their obligations because all the transactions had been pre-arranged”. The available evidence was such that the tribunal could be satisfied that the company’s transactions formed part of chains in which one or more of the transactions was or were “connected with the fraudulent evasion of VAT”, and Pharmaquim “knew or should have known of that fact”.

6. Although, as we have said, in the original decision letter the Commissioners alleged that Pharmaquim was involved in an “overall scheme to defraud the revenue”, they did not repeat the allegation in the statement of case. Nor did they identify the supposed participants in any such scheme or schemes. In the absence of any clear indication as to what the Commissioners might have meant by the allegation in the original decision letter, we are unwilling to accept that any findings we might make as to contrivance can amount to evidence either of one overall scheme, or of a series of schemes. In the circumstances, we propose to confine ourselves to dealing with the appeal on the basis of the allegations contained in the statement of case.

7. It is well established that the VAT system, whereby goods sold by a registered trader in one member State of the EU to a registered trader in another such State, has been exploited for fraudulent purposes on a huge scale. Losses to the UK Exchequer alone are said to run into billions of pounds. The question for us is not so much whether there has been fraud, but whether the Commissioners’ view of Pharmaquim’s knowledge and precautions taken against it is justified.

8. The type of fraud with which we are concerned is referred to as MTIC (Missing Trader Intra-Community) fraud. A common feature of it is that it involves trade in small, but valuable, items such as mobile phones. What happens in the type of deals with which the present appeal is concerned is that a UK registered trader purchases goods from a trader in another EU member State. The goods then usually change hands a number of times within the UK before being sold to an overseas trader which, if located in a member State of the EU, is registered for VAT in that State. Commonly all the transactions occur, if not on the same day, then within one or two days of the goods entering the UK; indeed, it is not uncommon for goods to enter the UK in the morning, and for them to be exported later the same day.

9. The UK trader acquiring the goods from abroad is required to, and does, charge VAT on the consideration paid by his purchaser but, instead of accounting for it to the Commissioners, he disappears with it. The documentation relating to his purchase is never produced to the Commissioners. For the scheme to work he must be a VAT-registered trader who provides the purchaser with a genuine VAT invoice, on the strength of which the purchaser claims input tax credit. The original purchaser’s own sale, and those of the other UK traders in the sequence, with the exception of the very last one, usually generate a small profit, which results in a small VAT liability for which those traders properly account. The last trader in the sequence exports the goods in a zero-rated supply, and thus has no liability to output tax. He is, however, entitled to reclaim the input tax he has paid, and it is that claim which the Commissioners deny, and which results in an appeal to these tribunals.

10. The Commissioners have developed a jargon peculiar to MTIC fraud. The UK importer who fails to account for the output tax charged to his customer is known as a “defaulter” or “missing trader”. The trader who exports the goods is called a “broker”, and those between the defaulter and the broker are called “buffers”. In the instant case, Pharmaquim’s input tax claim is based on its acting as a broker, but it is part of the Commissioners’ case that it also acted as a buffer. It is also the Commissioners’ case that the transactions were artificially generated, or orchestrated, and the goods were not bought or sold to meet any genuine demand, but rather simply to generate the input tax repayment sought by the broker, i.e. as a means of defrauding the Exchequer.

11. Between the extremes of traders who knowingly participate in frauds of this kind, who will be guilty of criminal offences, and those innocent caught up in frauds, are traders who know or have the means of knowing that their transactions are connected with fraud even though they are not themselves participants and who, for whatever reason, carry on with those transactions. Such traders aid the perpetrators of the fraud and become their accomplices (see para 57 of the judgment in Kittel), and they too lose the right of deduction. As Moses L J explained at para 41 of his judgment in Mobilx Ltd (in administration) v HMRC [2010] EWCA Civ 517, “Kittel did represent a development of the law because it enlarged the category of participants to those who themselves had no intention of committing fraud but who, by virtue of the fact that they knew or should have known that the transaction [in which they were involved] was connected with fraud, were to be treated as participants. Once such traders were treated as participants their transactions did not meet the objective criteria determining the scope of the right to deduct”.

12. The essential issues in the case are two, namely:

a) Were Pharmaquim’s transactions in respect of which the Commissioners have denied its input tax claims connected to the fraudulent loss of VAT elsewhere in the transaction chains? and

b) Did Pharmaquim know that its transactions were so connected, or should it have known that they were so connected?

13. Mr Richard Jones QC and Mr William Hansen appeared for Pharmaquim, and Mr Jeremy Benson QC and Mr Vinesh Mandalia for the Commissioners. Each party produced an opening statement, which we found most helpful.

14. We took oral evidence from the following witnesses:

Elaine Yvonne Emery, a member of the Commissioners’ MTIC Technical and Co-ordination team
Russell Martin Hall, an officer who was responsible for Pharmaquim until mid-2006 when he handed control of its affairs to Lesley Jane Cookman, and who subsequently presented Mrs Cookman’s evidence in the latter’s absence due to illness. (Mrs Cookman was the officer who issued the decision letter under appeal)
Helen Marie Harrison, another officer in the Commissioners’ MTIC team, who visited Pharmaquim on a number of occasions
Christopher David Harbidge, an employee of Norfolk Shipping Line BV
John Joseph Morrissey, the freight services manager of Seafrance
Dr Zaffer Khan, the director and owner of Pharmaquim

Peter Karl Hewston, a chartered accountant and a partner in the firm of Rochesters, Pharmaquim’s accountants

15. The statements of those witnesses who gave oral evidence formed their evidence in chief, but in some cases it was supplemented either to bring it up to date or for completeness.

16. In addition we were provided with the agreed statements of officers Lesley Jane Cookman, Nigel William Neale, Claire Badminton, Russell William Coulson, John Paul McPartlin, Nigel Neale, Justin Kruyer, Gary Felix Saul, Jonathan Carl Laing, Anna Louise Hudson, Smita Parikh and Roderick Guy Stone, the last mentioned providing an overview of MTIC fraud. We also had statements from John Fletcher, a principal adviser in KPMG LLP, who had been instructed by the Commissioners to assess the development and structure of the mobile phone handset industry generally and the size of the market in the EU and UAE, Derek Gardner, Nokia’s logistics security manager, and Rajan Ghai, a director of Interken Freighters (UK) Ltd, a freight forwarder used by Pharmaquim.

17. In accordance with what has now become standard practice, the statements were supplemented by documentary evidence extending to over 20 lever arch files.

18. It is from the whole of that evidence that we make our findings of fact.

19. However, before rehearsing our findings, there are two matters we should mention. First, in cross-examination Dr Khan admitted that most, if not all, of the deals concerned had been carried out by his manager, Mr Birdy. We had no statement or oral evidence from Mr Birdy, and the least we can say of the lack of such evidence is that it was unhelpful. Secondly, it was part of the Commissioners’ case that vans said to contain Pharmaquim’s stock crossing the Channel were in fact empty. The evidence of messrs Harbidge and Morrissey was intended to deal with that matter, but, in the event, failed to do so. We therefore reject claims by the Commissioners as to the emptiness of the vans, and say nothing more about them.

The facts

20. Pharmaquim, as Cormila Ltd, was incorporated on 21 November 2002. Dr Khan, who holds a Ph.D. in chemical engineering, is its sole director and shareholder, and was appointed to the former office on 3 January 2003. The Commissioners were informed of the change in the company’s name to Pharmaquim by letter of 11 May 2006.

21. In its application for registration, Form VAT1, of 22 January 2003, Pharmaquim disclosed its intended business as importing and exporting, but of what it did not say. The application stated that the company did not expect either to be buying goods from or exporting goods to traders in other EU member States and was accompanied by several business enquiry letters from prospective Pakistani customers expressing an interest in purchasing second-hand steel wheel rims and clear plastic bottles. The letter relating to the latter suggested that Pharmaquim might consider becoming an agent for importing and selling bottled water from Pakistan in the UK. The Commissioners questioned whether the enquiry letters were genuine as they were unable to find any evidence of the existence of their writers on the internet. Nevertheless, on 1 March 2003 they proceeded to register the company.

22. On 25 March 2003, officer Emery paid a visit to Pharmaquim, and was told that the company had been established to supply chemicals to WRK Design & Services Ltd (“WRK”), a company associated with Pharmaquim of which Dr Khan was also a director. WRK was said to be constructing a reactor to dissolve submarine exhaust fumes. Ms Emery was told that Pharmaquim’s annual turnover was expected to be about £200,000, with EU exports of approximately £30,000, and some exports to Switzerland. She also ascertained that the company planned no purchases from the EU, but did anticipate making some non-EU purchases that might not enter the UK.

23. In the year to 30 November 2003, Pharmaquim had fixed assets of £186. Its turnover was £13,489, and its expenses £12,664, so that its operating profit was a mere £825. The company had no working capital. In the year to 30 November 2004, its fixed assets fell to £124. Its turnover also fell, to £3890, and it had an operating loss of £2440. Again it had no working capital. No further accounts were prepared for the company until 30 (sic) May 2006. And, whilst chronologically out of order, we might disclose at this point that the accounts then prepared showed its turnover in the 18 month period to have risen to £225,099,958, and its fixed assets to £1383. Dr Khan acknowledged in evidence that the company did not trade in the period until April 2005, so that the accounts effectively covered but a 14 month period. They showed a loss of £544,260 resulting from bad debts totalling £1.8 million, the majority of which sum was owed by Broadcast Ltd (“Broadcast”), a company with which Pharmaquim continued to trade as late as April 2006.

24. By way of preparation for Pharmaquim’s entry into the market in electronic goods, Dr Khan told us that in 2003 and 2004 he attended a number of trade fairs and exhibitions where he was able to obtain information on telecommunication and computer equipment, as well as learning how trade in the industry functioned. He particularly drew attention to knowledge he had obtained on visiting a fair in Hanover, but admitted that none of the traders with which Pharmaquim subsequently dealt had stands at that fair, nor did he meet any of them there. Dr Khan further claimed to have met potential suppliers and to have conducted further research into trading on visiting China. However, in cross-examination he admitted that none of the mobile phones in which Pharmaquim dealt had been supplied from or had an official distributor in China, and that his first visit to that country was made in connection with his chemical engineering business. Dr Khan admitted having no knowledge of the extent of warranties that would have been available had Pharmaquim purchased phones from China. He claimed that as part of his research into the market, he “came across a number of sources and different trading portals”. Portals he identified included the websites of International Phone Traders (www.ipt.cc), a “real time trading portal for wholesale dealers in mobile phones”, International Computer Brokers (www.icb.cc), and International General Traders (www.igt.cc). In addition to becoming a member of each of those portals, Pharmaquim also joined the portals of European Phone Stocks (www.eups.cc), European Computer Stocks (www.eucs.cc) and Handset Trader (www.handsettrader.com). When later Pharmaquim’s services were advertised on those websites, Dr Khan maintained that it “significantly increased [its] exposure in the mobile phone trading market and [its] sales increased”. Having “followed the websites” in 2004, Dr Khan further claimed to have begun contacting companies advertising on the sites with a view to commencing trading with them. He added that he found Pharmaquim able to source stock requirements of customers and to negotiate competitive prices with them. However, he also discovered that before any company would trade with Pharmaquim, it required verification of its “legitimacy” from the Commissioners and from Companies House.

25. On 18 January 2005, apparently suspecting that Pharmaquim intended to start trading in the wholesale market in mobile phones, the Commissioners wrote to it explaining that it needed to verify the VAT status of new customers and suppliers, and required it to provide details of them, and the transactions into which it entered. That letter was followed by a visit by officer Helen Harris on 24 January. Dr Khan claimed to have been open with Miss Harris, and to have disclosed to her the names of the phone traders he had contacted. Miss Harris advised him of the risks associated with the wholesale phone market, drawing particular attention to the problem of missing traders. He was specifically advised not to make third party payments. Dr Khan claimed to have been unaware of the risks of MTIC fraud until Miss Harris’s visit, but admitted then having carried out his own research into the fraud. Nevertheless, he stated in evidence that he believed that whilst so trading Pharmaquim could avoid involvement in fraudulent transactions, adding that he “was very excited by the opportunities offered by the market”.

26. Following that meeting, Dr Khan claimed to have improved Pharmaquim’s verification procedure of companies with which it intended to deal using three different “methods”: (1) by checking the validity of their VAT registration numbers; (2) by obtaining oral confirmation of that validity from the Commissioners’ helpline; and (3) by making a faxed check with the Commissioners’ Redhill verification office. However, due to what he claimed to be a deterioration in the service offered by Redhill, Dr Khan said that instead of using its service, he quickly came to rely instead on that provided by the helpline. In the 10 weeks following the January 2005 meeting, Dr Khan said that he contacted potential customers and suppliers on a daily basis to ascertain their requirements. He similarly contacted suppliers to obtain details of stock availability. It was only at the end of that period of “extensive liaising and negotiation” that he was able to secure stock capable of being sold profitably. Further, although Pharmaquim dealt only in phones at the “top end” of the market, Dr Khan admitted having carried out no research into the size of the mobile phone market, and made no enquiries into the demand for particular makes and models of phones.

27. Pharmaquim first traded in mobile phones on 4 April 2005. Both its supplier and customer were registered with the IPT website. It carried out a second transaction on 14 April 2005, and a third on 26 April 2005. On 3 May 2005 Dr Khan informed Miss Harris of the three transactions, and also disclosed that the company had made third party payments. Having agreed to, he faxed her a weekly log of the sales Pharmaquim had carried out, including the make, quantity and models of phones dealt in. He also agreed to fax all future purchase orders, sales invoices, release notes and payment details, and Pharmaquim’s monthly bank statements.

28. Officers Hall and Harris visited Dr Khan on 14 June 2005, when he confirmed that Pharmaquim had made third party payments of 95 per cent of the value of certain goods the company had purchased. When asked how, in those circumstances, the company’s supplier would fund and pay its output tax liability, Dr Khan admitted that he had not considered the matter. The officers noted that Pharmaquim had previously been issued with Notice 726, “Joint and several liability in the supply of specified goods”, and themselves issued Notice 700/52, “Notice of requirement to give security, etc.”. Notwithstanding that he then undertook not to make third party payments, Dr Khan continued to do so during the remainder of June, saying that he did so merely to meet commitments into which Pharmaquim had already entered.

29. On 25 July 2005 officer Hall returned to Pharmaquim to obtain its bank account details, and details of the countries of origin of its third party payees, some of its sales being exported. During that visit Dr Khan informed Mr Hall that henceforth the company would make no third party payments. Mr Hall discovered that input tax claims Pharmaquim had made included 7 deals in which the company had been involved as a third party payer and led to a tax loss. He also found Pharmaquim to hold instructions to make third party payments running to 86 pages.

30. In August 2005, Pharmaquim engaged Rochesters, a firm of chartered accountants, to provide it with accounting services to included the preparation of accounts and annual audits. However, those services did not extend to its giving advice about dealing with potential suppliers and customers. The partner in Rochesters responsible for Pharmaquim’s affairs, Mr Hewston, admitted in evidence that for at least part of the period with which we are concerned, the company was “technically insolvent”.

31. On 6 December 2005 officers Hall and Griffiths visited Pharmaquim to collect its export documentation. At the same time they handed Dr Khan a copy of Notice 703, “Exports and Removals”. During the visit Dr Khan agreed to provide the Commissioners with CMRs, travel tickets, Interken Certificates of Shipment, and payment details of EU dispatches. (As we mentioned earlier, Interken Freighters (UK) Ltd was a freight forwarder used by Pharmaquim in a number of its transactions).

32. By letter of 6 March 2006, the Commissioners, in response to a change in Pharmaquim’s registration details, repeated earlier advice that the VAT system was under increasing attack from bogus applicants for VAT registration intent upon committing fraud, frequently running into millions of pounds.

33. It was at that point in events that Pharmaquim entered into the first deal with which we are concerned, Deal 1. Its other deals followed shortly afterwards.

34. In a letter of 3 May 2006, the Commissioners highlighted to Pharmaquim the circularity of goods being traded in the wholesale phone and CPU markets.

35. On 6 September 2006, officers Cookman and Hall uplifted Pharmaquim’s due diligence records for two of its suppliers. And on 11 September Mrs Cookman uplifted such records for its remaining suppliers.

36. From July 2005 to October 2005 Pharmaquim regularly exported goods to Switzerland. On 3 May 2006 Mr Hall issued a letter to Pharmaquim explaining that joint action was being taken by the Customs authorities in the UK, France and Switzerland to deal with artificial supply chains wherein goods exported from the UK and consigned to a freight forwarder just inside the Swiss border were then transported to a French forwarder before returning through a number of European countries to the UK. The letter went on to say that documents obtained by the Commissioners clearly showed that the goods concerned remained outside the UK for only between 48 and 72 hours, and that information held showed that many of the transactions began and ended with a UK trader that failed to meet its tax liability. We mention the letter merely as background information, since the Commissioners do not allege that any of Pharmaquim’s supplies to its Swiss customers play any direct part in events with which we are concerned.

37. Despite Dr Khan’s claim to have discovered a dynamic market, Pharmaquim ceased trading in mobile phones before the “reverse charge” mechanism for taxing such deals came into force in June 2007. It did so on Dr Khan being informed that the Commissioners had traced back one of its deal chains to a defaulter. He rejected the Commissioners’ contention that it did so because that charge made it impossible for a trader such as Pharmaquim to profit from MTIC trading within the trade sector, rather than trading in an ordinary market with genuine commercial opportunities to exploit.

Pharmaquim’s trading model

38. Before dealing with the various transactions which form the subject of Pharmaquim’s appeal, we propose first to explain the trading model the company adopted as described by Dr Khan. Whether Pharmaquim’s purchases and sales were conducted precisely as he described, we are unable to say for, as we mentioned earlier, it was the company’s manager, Mr Birdy, who was responsible for its negotiations and contractual arrangements. Nevertheless, taking Dr Khan’s evidence as a whole and considering the remainder of the evidence presented to us, we conclude that the various deals with which we are concerned were conducted along the lines indicated by Dr Khan.

39. As we mentioned earlier, Dr Khan said that he had discovered a number of trading portals, such as the IPT website, which he claimed to serve the genuine “grey market” in mobile phones, and that he determined to take advantage of the opportunities they offered Pharmaquim to act as middleman in matching purchases to sales. He also said that throughout the day wholesalers would post on such sites stock they wished to buy or sell, so that he was able to identify the stock requirements of potential customers and stock availability from suppliers. In cross-examination, he accepted that the wholesale trade in which he intended Pharmaquim to trade was “customer driven”, and that all those involved would be seeking to maximise their profits. He further acknowledged that the information available to Pharmaquim would have been available to all others having access to the websites.

40. Dr Khan described Pharmaquim’s trading model, particularly in broker deals, as requiring it first to ascertain a customer’s stock requirements and the price it was prepared to pay, and then source the stock for it. Sourcing entailed telephoning a supplier or suppliers for the purpose. Assuming a supplier was able to access the necessary stock at a price which would provide Pharmaquim with an acceptable profit, Pharmaquim would obtain a purchase order from its customer and, in turn, submit a purchase order to the supplier. Although the supplier would agree to hold the stock for a while, it would enter into no commitment to do so, and would reserve the right to supply the goods to another trader. Thus, Pharmaquim was at risk of the supplier selling the goods to another trader. In its purchase orders, Pharmaquim included only a general description of the make and model of the phones concerned, ignoring colour and other special features that were available. Dr Khan explained that it did so as he did not wish Pharmaquim to commit itself to an exact specification of goods it was purchasing.

41. Importantly, Dr Khan also stated that none of the companies with which Pharmaquim traded would deal with an importer, they well knowing that imported stock was frequently the subject of VAT fraud. Consequently, except on one occasion Pharmaquim did not act as an importer of stock. In the one transaction Pharmaquim did import goods, on 9 May 2006 it acquired from Polcomm Trading Sp.ZO.O, a Polish company, 10,000 Nokia 8800 mobile phones. It subsequently sold the entire consignment to a UK company, the Ikon Corporation Ltd, charging output tax against which it offset its input tax claim for period 06/06. In that single instance, the Commissioners claimed that Pharmaquim acted as a contra-trader. Dr Khan was unable to say why, when acting as a broker and dealing with a foreign customer, Pharmaquim did not seek to source the required goods abroad when by doing so it could have reduced the transport and associated costs for which the company was responsible, and thus achieved a greater profit.

42. The trading model required Pharmaquim to make no credit arrangements with those with whom it traded or to enter into credit agreements with its suppliers but, despite their absence, in all the deals with which we are concerned, the company was provided with and took advantage of such credit. Nor did it involve the company entering into any formal written contracts with its suppliers, customers or freight forwarders. The terms and conditions on which it traded were unclear; indeed if they existed at all, they were basic in the extreme. They provided no arrangements for matters such as the transfer of title, payment and delivery terms, returns and exchange arrangements for faulty or damaged goods.

43. Further aspects of the trading model took the following form. Invariably, stock in which Pharmaquim dealt would be held by, and throughout its own purchase transactions would remain with, the freight forwarder instructed by its supplier, or the forwarder for a supplier even earlier in the chain concerned. Pharmaquim would instruct that forwarder to act for it, and the stock would remain in the forwarder’s possession until Pharmaquim instructed it to dispatch it to Pharmaquim’s, customer, or the customer’s freight forwarder. Stock was never seen, or inspected, by Dr Khan or by Mr Birdy. No checks on freight forwarders were carried out by Pharmaquim.

44. Dr Khan claimed the model to include a “100 per cent inspection of the stock and a 10 per cent box check”, explaining that expression as meaning that each individual phone box would be counted, and 10 per cent of the boxes opened and checked to ensure that each contained the correct model of phone, the right charger, instruction manual, etc.. The freight forwarder or a specialist inspection agency would be instructed to carry out this inspection. In Dr Khan’s estimation, Pharmaquim could expect to receive an inspection report about 3 hours after requesting it. Despite the huge numbers of phones in which Pharmaquim dealt, no report was ever made of anything being out of the ordinary, and the speed at which reports were said to be prepared was regarded by the Commissioners as indicating that the physical checks required were not in fact carried out.

45. The stock inspection and box check did not extend to the recording of IMEI numbers, such numbers being unique to individual phones, and thus being capable of showing whether they had been dealt in previously or had been stolen. Dr Khan added that insurance cover for phones being transported abroad was generally arranged by the freight forwarder holding them. However, it appeared, and we find, that the conditions attached to the policies on offer were usually ignored by Pharmaquim. Consequently, we agree with the Commissioners who regarded it as doubtful whether, even though insurance cover was said to be in place, it covered the goods exported.

46. Dr Khan further explained that each trader in a chain would agree to release possession of goods to its customer to enable that trader in turn to transfer possession to its own customer. Such release was made orally, and not accompanied by a guarantee of payment. Despite Dr Khan claiming to keep memoranda of due diligence and critical conversations, he conceded that he kept no memoranda of such conversations, and held no authority from any supplier to export unpaid for goods effectively as their owner.

47. On Pharmaquim contracting to sell goods to an EU trader, the model provided for them immediately to be transported abroad, usually to that trader’s own freight forwarder. Dr Khan claimed that Pharmaquim was protected against loss in that they were so transported “on hold”; they would not be released to the EU trader until Pharmaquim received payment from the EU trader. So, notwithstanding that Pharmaquim had no title to the goods, not having paid its own supplier for them, Dr Khan maintained that on payment being made by the EU trader, they would be released to that trader to deal with as it wished.

48. Dr Khan described the market serving the model as “fast moving and dynamic with genuine opportunities for exploitation”, and claimed that in dealing in it speed was of the essence. Whether he meant that speed in carrying out transactions was intended to be confined to the paperwork and movement of goods, as was in fact the case, was unclear. It was plain from the evidence that it did not extend to payment for them. As to payment, Dr Khan claimed the model to provide for goods to pass through a whole chain of transactions, eventually to be exported, and for no money to change hands until the goods arrived at the EU customer or its freight forwarder. Thereupon, that customer would pay its supplier, and payment for the goods would then cascade down the chain, each participant deducting its profit in the process, until it eventually reached the true owner of the goods. Correspondingly, title to the goods would ascend the chain. The way in which the payments system was said to, and did indeed, operate is clearly illustrated in the table of Pharmaquim’s transactions which forms the First Schedule to our decision.

49. Whilst dealing with payments, we might mention that in the period with which we are concerned Pharmaquim and all its suppliers and customers banked with and used their accounts at the First Curacao International Bank (“FCIB”) of the Dutch Antilles for the transactions in the various deal chains. All payments were made by intra-bank transfers, so that in many cases they passed through the accounts of all the traders in a deal chain in a single day. FCIB’s banking licence was withdrawn by the Dutch authorities in October 2006. We should also mention that all the transactions were conducted in sterling.

50. Dr Khan did not explain why, again in those circumstances, the EU trader would make payment to a broker such as Pharmaquim well knowing that it had no title to the goods supplied, and would not obtain such title until payments made their way through however many buffers were involved in the relevant deal chain above the broker, such traders and their number said to be unknown to it. Nor did he provide any evidence as to why, unlike every other trader in the chain, the EU importer would unilaterally pay its supplier.

Pharmaquim’s transactions

51. We then procced to deal with the twenty transactions in point in the appeal. By way of introduction we repeat that in Pharmaquim’s two accounting years 2002/03 and 2003/04 the company had no working capital. No evidence was adduced to indicate that any capital was later introduced so that we proceed on the basis that the only capital it ever had consisted of profits generated by its trading activities. Pharmaquim started trading in mobile phones as a buffer in April 2005, but we were provided with no evidence as to when it changed to acting as a broker. However, since it was a repayment trader in period 03/06, it must have started so trading no later than that period.

52. The little evidence adduced as to the company’s trading as a buffer showed that in period 06/06 it acted as such in no less than 72 transactions in mobile phones, and in 70 of them its profit per handset was 50p. So even in a transaction involving, say, 5000 phones its profit would have been a mere £2500. Profits so small would have been wholly insufficient to provide the working capital Pharmaquim needed to enable it to enter into the very large broker transactions into which it did in fact enter, they requiring it to finance its input tax liability pending repayment by the Commissioners.

53. Pharmaquim’s lack of working capital resulted in its being unable to pay some of its creditors as their debts became due. That most clearly manifested itself in relation to Deal 16 where, as we shall shortly explain in detail, Pharmaquim, instead of making payment to its supplier in cash, arranged to provide consideration in the form of O2 Top-Up vouchers. The table in the First Schedule to our decision also clearly illustrates the delay in payments.

54. Dr Khan explained that Pharmaquim was unable to deal with retailers who did not obtain supplies direct from manufacturers or authorised distributors as they were unwilling to trade in quantities as large as those in which the company dealt.

55. The phones dealt with in the deals, with the possible exception of those in Deals 5 and 18, all had 2-point European chargers, and so were incapable of use in the UK without adaptation.

56. We observe that the phones involved in Deals 5 and 18 were Nokia 8801 models. The Commissioners adduced evidence to show that that model was designed for use in north and Latin America. (It was the American equivalent of the European Nokia 8800).

Period 03/06

57. The one transaction in period 03/06 with which we are concerned, Deal 1, resulted in Pharmaquim ultimately being assessed to tax of £269,500. The deal chain reconstructed by the Commissioners commenced with a Cypriot company, Macdelta Ltd (“Macdelta”). That company either directly or indirectly supplied 5000 Nokia 9500 phones to Euro Imports & Exports Ltd (“Euro”), and received 6 third party payments totalling £1,685,000 between 18 April 2006 and 26 April 2006 from B Logistics UK Ltd (“B Logistics”), a company appearing as a buffer in the reconstructed deal chain. Euro sold the entire consignment of phones on 24 March 2006 at a price of £305.90 per handset plus VAT, but then failed to account to the Commissioners for the tax of £267,662.50 charged to its purchaser, Park Supplies Ltd (“Park”). Euro then disappeared. Park sold on the consignment to AC Electrical EU Ltd (“AC”) at a price of £306.25 per handset, plus VAT, and AC immediately sold them to B Logistics at the same price per handset as it had paid Park for them. AC and B Logistics were each instructed to pay £5025 to Park. B Logistics sold the consignment to Xcel Solutions Ltd (“Xcel”) at a price of £307.50 per handset, plus VAT. Xcel then sold the consignment to Pharmaquim at a price of £308 per handset, plus VAT. All the transactions to which we have thus far referred were, with the possible exception of the original sale by Macdelta, carried out on 24 March 2006. We say “possible exception” in relation to the original sale as the Commissioners were apparently unable to trace Macdelta’s part in the transactions through invoices and other standard sale and purchase documentation, having only the third party payment instructions to B Logistics as evidence of Macdelta’s involvement in the chain. Dr Khan claimed that Pharmaquim’s unidentified purchaser of the phones failed to complete the transaction, and the company was left to dispose of the phones as best it could. It was not until 11 April 2006 that Pharmaquim sold the phones, and it did so at a loss of £140,000. The price it obtained from its purchaser, URTB Sarl (“URTB”) of France, fell to £280 per handset. As we mentioned at the outset, Pharmaquim was initially repaid the input tax on its purchase, but has now been assessed to the sum in question.

58. Mr Benson suggested to Dr Khan that the loss on the sale Pharmaquim incurred was engineered, and was required to ensure that the phones concerned could continue to be supplied in a wholesale roulette arrangement. Dr Khan rejected that suggestion, but claimed to be unable to recall the name of Pharmaquim’s original customer which failed to proceed with its purchase on 24 March 2006. Judged against the background of the remainder of the evidence before us both as to the loss and generally, and Dr Khan’s claimed inability to be able to identify the trader responsible for Pharmaquim’s substantial loss (a claim, incidentally, we do not accept), the only reasonable explanation for the loss is that it was engineered as Mr Benson suggested.

Period 06/06

59. In period 06/06 Pharmaquim entered into 19 transactions as a broker, and in each case its corresponding claim to input tax credit was denied by the Commissioners. In every one of the 19 deals concerned, Pharmaquim bought from a UK registered trader and on the same day sold back-to-back, i.e. the same make, model and quantity, in a zero-rated sale to a customer resident in the EU. In each case Pharmaquim’s supplier accounted for the output tax on its sale, after deduction of the input tax on its purchase. Each chain essentially followed the pattern of the Deal 1 chain, starting with an importation by a trader who subsequently disappeared having failed to account for the VAT it had charged its customer. Each importation was followed by a number of buffer deals, and ended with Pharmaquim’s broker deal. But, in contrast with Deal 1, all the remaining deals, except Deals 13 to 15, resulted in a profit, and all were all carried through in a single day. The Commissioners did not say that Pharmaquim knew that the goods had passed through the hands of so many traders in a single day, or that it knew the identity of the participants in the deal chain, other than its own supplier and customer.

60. The transactions involved but 6 suppliers and 3 customers. Of the suppliers, one, Xcel, was involved in 11 transactions, another, High Speed Business Ltd (“High Speed”), in 4, and the remaining suppliers in one transaction each. Of the customers, the first, URTB, was involved in 6 transactions, the second, Sigma Sixty BV (“Sigma”) of Holland, in 5, and the third, GTC Sarl (“GTC”) also of France, in 8. Mr Hall, who, as we have said, gave evidence for the Commissioners in the absence of Mrs Cookman due to illness, by enquiry of other officers and interrogation of the Commissioners’ computer records, explained that they had been able to trace the transactions back several further steps until in each one they reached a missing, i.e. defaulting, or hijacked, trader. Mr Jones did not challenge that analysis, and we accept it as being correct.

61. As we mentioned above, Pharmaquim made a loss in each of Deals 13 to 15. Quite how it came to do so when it would not have submitted its purchase order until it had received a similar order from its customer was not explained by Dr Khan. In the circumstances, again the only reasonable explanation for the losses is that they were engineered.

62. The 19 chains were set out in diagramatic form on “deal charts” presented to us. They showed the transactions between the various traders which had dealt with the handsets prior to their being supplied to Pharmaquim, and Pharmaquim’s sales to its customers. All the chains concerned included third party payments and/or third party payment instructions by at least one company in the chain. Further, the Commissioners were able to show the involvement of Macdelta at the head of all but two of the chains. In those two chains, third party payments were instructed to be made to a company called Amex, the documents for which were faked by a Mr Jarkiewicz, a known MTIC trader.

63. Each deal chart was supported by a deal pack containing a large number of documents, only to some of which were we taken. And since Mr Jones acknowledged that the Commissioners had correctly identified each deal chain and Pharmaquim’s part in it, and that the evidence served by them proved all the tax losses alleged (facts we too accept), we consider it unnecessary to consider their contents in detail. For the convenience of the reader, we have summarised all 20 transactions before us in tabular form in the Second Schedule to our decision. We particularly note the remarkable similarity in the mark-ups obtained by Pharmaquim in five separate groups of deals, namely 2-5 (2%), 6-9 (1%), 10-12 (2%), 16-18 (4%) and 19-20 (4%). In all the deal chains there was a distinct progression of profits through the various buffers concerned, starting at 75p per handset, then 35p, 75p, sometimes then 50p, back to 75p, followed by a further 50p, before the goods came into Pharmaquim’s hands.

64. In relation to Deals 1 and 6, each of which was said to have been of 5,000 Nokia 9500 phones, the Commissioners adduced evidence based on research by GfK, a reputable market research company, showing that in April 2006, the month in which the two transactions took place, Nokia’s total retail sales of 9500 phones in Europe was 6,378. Since Pharmaquim’s purchase in Deal 6 took place on the day immediately following its sale in Deal 1, the Commissioners invited us to infer that the phones involved in the two deals were the same ones. Despite Mr Jones submitting we should not do so since the evidence adduced by the Commissioners related solely to the retail market, whereas Pharmaquim dealt only in the wholesale market, we do so infer, not only on the basis suggested by the Commissioners, but also against the background of all the remaining evidence.

Pharmaquim’s suppliers

65. Dr Khan did not visit Pharmaquim’s suppliers, as might have been expected of him, but rather delegated that task to a student. Consequently, he did not personally know the persons behind the companies with which Pharmaquim was dealing.

66. He maintained that the primary focus of Pharmaquim’s due diligence was on its suppliers rather than its customers, the former being the more likely to “go missing”, and to default in payment of VAT. Dr Khan contended that those risks not only served to sharpen up Pharmaquim’s procedures, but also to ensure that its primary focus was “upstream”. Having noted that the Commissioners had criticised the company’s procedures, he observed, and we accept, that nowhere did they suggest that the procedures failed in their primary task of ensuring that Pharmaquim did not deal with a defaulter. He further maintained that if transactions appeared commercial, in the absence of any evidence of fraud they were commercial. Large turnover in a high volume, high value market was not evidence of fraud, nor were “unusual” features which were accepted as the norm in the market in which Pharmaquim traded. His claims as to the commerciality of the deals, and the absence of evidence of fraud are matters with which we shall shortly deal.

67. Dr Khan explained that every deal Pharmaquim carried out generated the following documentation:

a) a customer purchase order

b) an invoice to its customer

c) a purchase order to its supplier

d) an invoice from its supplier

e) a release note addressed to its customer

f) payment records for both customer and supplier

68. He added that the terms and conditions on which Pharmaquim dealt with suppliers were incorporated into its purchase contracts. And, in relation to each of its purchases, its supplier was required to sign a supplier declaration containing the deal information and requiring confirmation that:

a) all goods were brand new with full manufacturer’s warranty;

b) the goods were supplied at their current market value;

c) the supplier had not previously supplied the goods to Pharmaquim; and

d) its supplier details had been checked with and confirmed by the Commissioners.

69. We accept that it did produce such documentation, but whether its contents were correct, or Dr Khan took any real interest in ensuring they were, we doubt. We further accept that Pharmaquim filed and recorded the documentation to a very high standard, as we believe the Commissioners also accept. We further accept that Pharmaquim obtained and recorded to the same high standard the other documentation a reputable trader would have prepared and held in relation to its deals, but again we doubt its correctness or whether Dr Khan took any interest in its correctness.

70. Pharmaquim’s supplier in the 12 Deals numbered 1, 2, 6, 7, 11, 12, 14, 15, 16, 18, 19 and 20 was Xcel Solutions Ltd (“Xcel”). As was the case in relation to all its other suppliers, Pharmaquim obtained for Xcel a letter of introduction, its Certificate of Incorporation, VAT certificate and bank details. The letter of introduction was couched in the most general of terms whilst exaggerating the size of Xcel’s business and the experience of those running it. Pharmaquim carried out its first deal with Xcel on 18 November 2005, but did not carry out a Redhill check on it until 22 November 2005. It produced to the Commissioners an indistinct photograph of premises, but there was nothing to connect them to Xcel. The company’s VAT certificate showed Xcel as selling and maintaining motorcycles. Dun and Bradstreet, in a report of 21 January 2006, found itself unable to assess Xcel’s credit risk due to no relevant information being available. Xcel provided Pharmaquim with two trade references, the first of which was not followed up until 5 May 2006 by which time Pharmaquim had purchased many millions of pounds worth of stock from it.

71. Deals 14, 16 and 20 all took place in June 2006, and Pharmaquim’s customer in each one was GTC. Pharmaquim was paid for the goods supplied in Deal 14 on 2 and 3 August 2006, and issued a release note to GTC on 7 August 2006. It was paid for the goods in Deal 16 on 10 July 2006, and issued a release note the same day. It was paid for the goods in Deal 20 on 11 July 2006, and again issued a release note the same day. In each of Deals 14 and 20 Pharmaquim made payment for the phones purchase4d on the same day as it was paid for them by its customer. Pharmaquim did not make payment for the phones comprised in Deal 16, and on 31 January 2007 the Commissioners were informed by Rochesters that it had “cleared its debt” with Xcel by selling that company 173,220 £20 O2 top-up vouchers purchased from Maktrim, a Polish company. The Commissioners subsequently discovered that as late as 13 April 2007 Maktrim had not been paid for those vouchers. They also discovered that Xcel had sold the vouchers to AW Associates Ltd, a defaulting trader deregistered on 16 August 2006, but that no money had changed hands, AW Associates Ltd having owed Xcel a sum equal to the consideration for the transaction.

72. Futuristic Electronics Ltd (“Futuristic”) was Pharmaquim’s supplier in Deal 3. Futuristic was incorporated on 3 December 2004, and registered for VAT on 10 February 2005. Futuristic provided an undated letter of introduction which even Dr Khan acknowledged to be “slightly exaggerated” in its claims. Pharmaquim produced two photographs to the Commissioners of office premises said to be those of Futuristic. In neither was there anything to connect the company to the premises. A Companies House report showed it as not having to file accounts until 3 October 2006. The first deal between Futuristic and Pharmaquim took place on 28 July 2005, and by the end of the same month Pharmaquim had purchased stock from it totalling over £2.5 million. Pharmaquim requested a Dun and Bradstreet report on 1 August 2005, and when received it showed there to be insufficient information to provide Futuristic with a credit score. Nevertheless, Pharmaquim continued to trade with it. Although Futuristic provided two trade referees, Pharmaquim failed to take up a reference from either of them. Pharmaquim obtained a further report on the company from ‘The Security People’. It was dated 28 March 2006, some 8 months after the two companies commenced trading with each other, and showed Futuristic’s turnover in the previous year to be £350 million, and its estimated profit to be £2 million. The report contained no credit rating for the company.

73. In Deal 4, Pharmaquim’s supplier was Broadcast. That company was incorporated on 5 March 2003, but did not register for VAT until 19 October 2005. Broadcast produced a letter of introduction to Pharmaquim, which again Dr Khan accepted contained exaggerated claims. Those claims were not investigated, according to Dr Khan, due to his relying on checks he would have expected the Commissioners to make into the company. A Companies House report produced by Pharmaquim showed the company having last submitted accounts to 31 March 2005, at which date the company was dormant. A Dun and Bradstreet report of 23 June 2006 showed the company to be risk 3 – high risk of business failure – and recommended a maximum monthly credit of £1,500. Pharmaquim made its first purchase from Broadcast on 28 February 2006 in a sum in excess of £1.5 million. As we mentioned earlier, Pharmaquim’s accounts to 30 May 2006 showed bad debts totalling over £1.8 million, the vast majority of which sum was owed to it by Broadcast. Subsequently, Pharmaquim successfully petitioned the court for the compulsory winding up of Broadcast.

74. Mana Enterprises Ltd (“Mana”) was Pharmaquim’s supplier in Deal 5. One trade reference obtained as part of Pharmaquim’s due diligence showed its provider, Electron Global Ltd, to have started to trade with Mana as late as 17 February 2006. Due diligence evidence produced to the Commissioners included an indistinct copy driving licence of one of Mana’s directors, and photographs said to be of the directors and the company’s business premises – a corner shop advertising ladies and children’s clothing. Its VAT certificate showed its trade class simply as “wholesale”. Again Pharmaquim obtained a Dun and Bradstreet report, on this occasion on 21 June 2006 – three months after Pharmaquim started to trade with Mana – showing a risk score of 3 – a high risk of business failure and suggesting a maximum monthly credit of £6,750. The first two deals Pharmaquim carried out with Mana on 16 March 2006 were worth in excess of £1 million. The report also showed that Mana traded as Mia Fashions wholesaling clothing.

75. High Speed featured as Pharmaquim’s supplier in Deals 8, 9, 10 and 13. Its VAT certificate showed its trade classification as the sale of motor vehicles. Of three photographs Pharmaquim produced, two were said to be of Ferhaan Mahmood, High Speed’s director, and the third to be of its business premises, although there was nothing to connect the company with the premises. A Companies House report showed that the company had filed no accounts, and a Dun and Bradstreet report requested on 22 June 2006 – approximately two months after Pharmaquim started trading with High Speed – showed it to have insufficient information to provide High Speed with a risk score. One of the two trade references provided by High Speed was from Excel, and indicated that the two companies had first dealt with each other on 20 April 2006.

76. Deal 17 involved supplies made to Pharmaquim by The Export Company (“Export”). Pharmaquim provided two photographs to the Commissioners, one of Export’s director, Arshad Mahmood, and the other said to be of the company’s business premises, but containing nothing to indicate that Export operated from those premises. Export’s VAT certificate stated that the company carried out “service activities not specified elsewhere”. A Dun and Bradstreet report of 20 July 2005 – that date being two months after Pharmaquim started trading with Export – stated that it had insufficient information to enable it to provide a credit rating for Export. Export itself provided two trade referees, but Pharmaquim took up only one reference, and then only some 5 months after it first dealt with Export.

77. In addition to the reports to which we have already referred, Pharmaquim also obtained due diligence reports on a number of its suppliers from The Security People. The Commissioners questioned whether, on the facts, such reports were prepared on the dates they bore. They did so on the basis that the appellant company’s name was only changed from Cormila Ltd to Pharmaquim Ltd on 10 May 2006, and the reports, all of which were addressed to Pharmaquim, were dated:

Name of company Date of report

Xcel 3.4.06

Futuristic 28.3.06

Mana 10.5.06*

Broadcast 9.5.06

Export 16.2.06

High Speed 9.5.06

*same date as change of name

78. Since Dr Khan offered no explanation why reports dated prior to Pharmaquim’s change of name were nevertheless addressed to it, we conclude, and thus find, that the Commissioners’ claim that, with the exception of the report on Mana, they were not prepared on the dates they bore is correct. In any event, since each report was prepared after Pharmaquim commenced trading with the company concerned, we are not prepared to accept the reports as forming genuine due diligence checks.

79. No evidence was adduced by Pharmaquim to show that any of its supplies carried out any due diligence on the company and, in its absence, we find that none of them did so.

Pharmaquim’s customers

80. In relation to Pharmaquim’s sales to EU traders, the Commissioners say that its due diligence was “incomplete”; it did not take steps to ensure that it did not become involved in fraudulent deal chains. There was nothing to prevent any overseas customer from “running off” with the stock and prudence would have suggested payment for stock “up front”.

81. The evidence adduced by the Commissioners established that Pharmaquim obtained no bank references, business plans or annual accounts for any of its customers. (We might observe that in our judgment the obtaining of such accounts is realistic, whereas the obtaining of management accounts, as suggested by the Commissioners, is not). Consequently, Pharmaquim had no information as to the solvency or otherwise of its customers. The due diligence carried out on them consisted mainly of Veracis and Dun and Bradstreet reports. (Veracis is another credit rating agency). None of the reports prepared by Dun and Bradstreet and only one of the Veracis reports were obtained before Pharmaquim began trading with the customer concerned. All showed a significant level of risk of business failure in dealing with the customer. No trade reference was obtained for any overseas customer. Nor did Pharmaquim take out credit insurance to cover its overseas transactions.

82. We then turn to deal with the Commissioners’ evidence in more detail. As we mentioned earlier, the customers to which Pharmaquim made supplies in period 06/06 numbered but three. In relation to the first, URTB, Pharmaquim produced as evidence of its due diligence checks a letter of introduction, URTB’s VAT certificate, its Certificate of Incorporation, and its bank account and freight forwarder details. The Veracis report showed that URTB was visited by appointment on 6 April 2006, and Ms Lynda Bouraud, the lady responsible for the day-to-day conduct of its affairs interviewed. She disclosed that the managing director of the company, Mr Mayers, was a French national who lived in Spain, and the company’s other director was Mr David Suarez, a Spanish national who also lived in Spain. The report indicated that, although the company had been incorporated in February 2002, it was not until 21 October 2005 that it registered for VAT. It commenced trading in November 2005. No stock was handled at the company’s premises – an office in a fashionable part of Paris – and inspection of stock was restricted to basic box counts. Serial numbers of phones and IMEI numbers were not requested. The report contained a number of “negative indicators”, including that the company carried out limited due diligence, traded on a “trust basis”, had commenced trading recently, and had no track record of trading and tax compliance. An accompanying Dun and Bradstreet “European Compact Report” showed its D&B rating as “GG4”, i.e. GG to have financial strength of 10,001 euros, and risk indicator 4 to “represent significant level of risk”.

83. Pharmaquim’s second customer, Sigma, was also the subject of a Veracis report. It was visited on 22 June 2006 – a date after all that company’s transactions with Pharmaquim were completed. The report showed that Sigma operated from a “single room office…4 mtrs square” in central Rotterdam. The interviewer met Inge Egas, a Dutch citizen, who disclosed that its two directors lived in Dubai. One of the two, Mr Kenneth Thorne, a UK citizen, was shown by Companies House records to be a director of a UK company in liquidation, and to “have” 10 other companies listed, all of which had been dissolved between 2000 and 2005. Sigma was established in January 2004, and, although the interviewee claimed it to have capital of between £500,000 and £600,000, no evidence was adduced in support of that claim. The accompanying Dun and Bradstreet credit report showed the company to have tangible net worth of 17,947 euros based on its accounts at 31 December 2004, and to have a “4” rating, indicating a high risk of business failure. Amongst the negative indicators identified in the report were that Sigma “only commenced trading in the wholesale mobile phone market in November 2005”, that no current financial information was available or disclosed, and that it had a low Dun and Bradstreet credit rating.

84. Pharmaquim obtained a Veracis report on its third customer, GTC, prior to dealing with that company, a report which Dr Khan acknowledge as containing a “lot of discrepancies”. It was based on a visit to the company on 21 April 2006 followed by a lengthy telephone conversation on 18 May 2006. It business premises were said to consist of one large room containing “two desks, with very little equipment to show and no evidence of any commercial documentation or activity”. The interviewee was Mr Timothy David Mason, a British national and the company’s only director. Companies House records showed Mr Mason to have been an officer of 15 companies, “the majority of which have been dissolved”. Mr Mason admitted having had no previous experience of mobile phone trading prior to January 2006. GTC registered as a limited company in June 2005. Again, a Dun and Bradstreet report was obtained and, again, it contained a risk indicator of “4”, largely based on the company’s recent incorporation and there being no current financial or significant information available. Mr Mason disclosed GTC’s turnover in the month of March 2006 as “about £25 million”. In cross-examination, Dr Khan accepted that the Veracis report revealed a “lot of discrepancies”, but maintained that Pharmaquim reduced the risks involved in trading with it by shipping goods “on hold” pending payment for them.

Question 1: Were Pharmaquim’s transactions in respect of which the Commissioners have denied its input tax claims connected to the fraudulent loss of VAT elsewhere in the transaction chains?

85. Again, as we mentioned earlier, Mr Jones accepted that the Commissioners had established tax losses in all the deal chains with which we are concerned. But he required them to prove that such losses were fraudulent.

86. The Commissioners identified seven defaulting traders with which Pharmaquim’s transactions were connected, and the evidence of fraud they adduced in relation to each one may be stated relatively shortly. In relation to Deal 1, the defaulting trader in the deal chain was Euro Exports & Imports Ltd (“Euro”), and the officer responsible for dealing with that company was Mr Justin Kruyer. The output tax on the supply made by Euro in the deal in Pharmaquim’s chain was £267,662.50. Euro was assessed to that sum on 27 November 2007, and did not appeal the assessment. The tax assessed has not been paid. That may not have been surprising since the company was in liquidation, and was de-registered on 30 March 2006. From annual turnover of £75,177 in the year to 31 October 2004, falling to £41,509 and £58,343 in the two following years, Euro’s turnover rose exponentially to £85,470,435 in the three months ending on 28 February 2006. The Commissioners’ enquiries showed that Euro had become involved in MTIC deals initially as a first-line buffer, and then as an acquirer of goods from the EU. The company habitually requested its customers to make third party payments. Following an investigation by the Commissioners, Euro “went missing” on 30 March 2006. It was issued with a regulation 25 letter requiring it to make a return for the period 1 March 2006 to 29 March 2006. It failed to make that return.

87. The second defaulting trader identified by the Commissioners was Apollo Communication Centre Ltd (“Apollo”), which featured in the chains leading to Deals 2, 3, 4, 5 and 6. The officers responsible for the affairs of that company were Claire Badminton, Sunita Parikh and Chris Weston. The output tax on the supplies made by Apollo for the five deals totalled £881,732.70, and was the subject of assessments made on 3 December 2007 and 13 March 2008. The assessment has not been paid. By letter of 27 September 2007, the director of Apollo, Mr Ali Rahman, was required to provide a ledger account for each of his suppliers, and evidence of bank accounts into which payments were made. Mr Rahman failed to meet those requirements, which were made as a result of the Commissioners establishing that a purported supplier of goods to Apollo had had no dealings with the company and, indeed, knew nothing of it or its director. When confronted with that information, Mr Rahman accepted it as the truth. On 24 April 2006 Mr Rahman was served with a regulation 25 letter requiring an immediate VAT return for the company. He informed the serving officers that Apollo was unable to meet its VAT liability, so that the company’s VAT registration was immediately cancelled. The turnover of the company in April 2006 had by then exceeded £150 million. Yet the following day Mr Rahman produced a VAT return showing output tax liability of £4,038.89, claiming to have raised credit notes in respect of Apollo’s supplies to customers. As no evidence of the reversal of any transactions was produced, the Commissioners considered Mr Rahman’s actions to be designed to evade Apollo’s liability to VAT. In support of their claim in that behalf, they observed that since other traders within the relevant deal chains claimed to have been able to trade in the goods sourced from Apollo that constituted evidence of their involvement in a scheme to defraud the revenue. In a disqualification undertaking, given by Mr Rahman under s. 1A of the Company Directors Disqualification Act 1986, he undertook not to be involved as a company director for a period of 13 years without leave of the court. In his undertaking, he acknowledged having carried out inadequate checks on Apollo’s trading partners, and the company having traded at significant risk to the Revenue “giving rise to an unsatisfied VAT liability of at least £35,433,266…” Again, the company was in liquidation.

88. SS Enterprises Ltd (“SS”) featured in 3 deal chains involving Pharmaquim, Deal numbers 7, 8 and 9. The output tax on those deals totalled £143,840.90, which sum was included in assessments made against SS on 19 June 2006. Those assessments have not been appealed or paid. The officer responsible for the affairs of SS was Gary Felix Saul. SS was incorporated on 13 February 2006, registered for VAT on 3 April 2006, and was de-registered on 11 May 2006. It has since gone into liquidation. In its Form VAT 1, SS declared its intended business activity as “Trading in art, decorations, furniture, rugs of African and European style”, and its expected turnover in the 12 months following registration as £150,000. On 10 May 2006 Mr Saul paid an unannounced visit to the company’s principal place of business, a residence on a council estate. SS was served with a regulation 25 notice requiring a VAT return to that date. Mr Saul and another officer returned the following day and uplifted the company’s documents. They showed that between 28 April 2006 and 11 May 2006 SS had acquired goods from the Cypriot trader Macdelta, Spanish trader Marabo International and from Portuguese trader Cassus, and to have sold the goods to UK traders including Park. The Commissioners subsequently calculated their loss from SS at £14,240,764.54, which sum they proceeded to assess. The Commissioners found that SS never received payments for goods it supplied, but merely issued third party payment instructions to its customers.

89. Isales (London) Ltd (“Isales”) also featured in three deals in chains involving Pharmaquim, Deals 10, 11 and 12. The company was incorporated on 21 December 2005, was registered for VAT on 16 February 2006, and deregistered on 22 May 2006. The output tax due on those deals totalled £983,640, and was included in an assessment dated 25 May 2006, which assessment has not been appealed or paid. The officer responsible for Isales was Jonathan Laing. In its Form VAT 1, Isales disclosed its trading activity as “Wholesale of household goods, medical equipment + electronic goods, e.g. fridges – ovens, etc.” When officers visited the company on 22 May 2006, the director confirmed that it had been dealing in mobile phones for less than a week, and on two days alone had completed 60 deals resulting in a potential output tax liability of £11,589,040. Isales issued its customers with third party payment instructions requiring them to pay only a small profit to the company itself. By reason of its third party payment instructions, Isales was unable to meet its VAT liability. For instance, by its invoice 038 Isales was said to have sold 6000 Nokia N80 phones to Park for £2,186,400, plus VAT of £382,620. Isales instructed Park to pay £2,181,900 to Macdelta and £5,287.50 to Isales.

90. The Commissioners’ officer responsible for Udeil Solutions Ltd (“Udeil”) was Mr John McPartlin. He found it to feature in three of Pharmaquim’s deal chains, those including Deals numbered 13, 14 and 15. The output tax due on those deals totalled £870,021.25, and was assessed on Udeil in 2006. It has not appealed or paid the assessment. Udeil was incorporated on 19 September 2005, registered for VAT on 16 February 2006, and was de-registered on 8 June 2006. In its Form VAT 1, the company indicated that it expected its turnover in the 12 months following registration to be about £70,000. In the seven month period expiring on 30 April 2006, the company had turnover of £14,731, but in the following two weeks it turned over £51 million in deals in mobile phones. That was a different trade from that indicated in Form VAT 1, “information technology and financial consultation”. On 8 June 2006, a regulation 25 letter was served on Udeil. It required a VAT return for the period 1 May 2006 to 8 June 2006. As that return was not made, the Commissioners cancelled the company’s registration being satisfied that it had been a willing participant in trade in relation to which it had no intention of accounting for the VAT it charged on its invoices. On 31 May 2007 Mr. Leonardo Udeh, Udeil’s director, signed an undertaking under s.1A of the Company Directors Disqualification Act 1986 that for a period of 12 years he too would not act as a director of a company or be involved in company promotion, formation or management without leave of the court. In his undertaking, Mr Udeh admitted that between 25 May 2006 and 6 June 2006 he “caused Udeil to undertake a method of trading which put HMRC at risk of being subject to missing trader intra-community fraud and resulted in it having a liability for unpaid VAT in the sum of at least £6.4 million…” By order of the High Court of 20 September 2006, Udeil was compulsorily liquidated.

91. The company featuring in the chains involving Pharmaquim’s Deals numbered 16, 17 and 18 was Universal Appliances Ltd (“Universal”). The output tax due from Universal on those three deals was £221,207.01, which sum was assessed, and the assessment has not been appealed or paid. In Universal’s case, its intended business activity was declared in its Form VAT 1 as “the selling of household electrical items”. The company was incorporated on 23 March 2006, registered for VAT on 16 May 2006, and deregistered on 14 June 2006. Universal was later dissolved. As a result of a company making a Redhill enquiry about Universal, an unannounced visit to it was triggered. The visiting officers found the company’s stated principal place of business to be a flat in a high-rise block said to be the residential address of its director, Mr Asdullah Riaz. After the officers had failed to make contact with Universal in three visits, it was served with a deregistration letter. When later questioned about deals entered into by Universal, Mr Riaz claimed that he had done nothing more than sell a few DVDs and video recorders to his family. He claimed that someone had stolen Universal’s company details and made deals in mobile phones.

92. JD Telecom (UK) Ltd (“JD”) featured in the chains involving Pharmaquim’s Deals 19 and 20. Officer Nigel Neale was responsible for JD, and his enquiries revealed it to be a hijacked trader, i.e. a taxable person purporting to be JD had defaulted on the output tax due on the supplies made by the company in the two deals, totalling £460,880. That sum was included in an assessment made against the company. The sum assessed has not been paid, nor has the assessment been appealed. On making an unannounced visit to the stated principal place of business of JD on 30 June 2006, the visiting officers found the premises to be occupied by Crest Telecom Ltd. Consequently, a regulation 25 letter was left in the mailbox for JD. The officers returned on 3 July 2006 to find the letter had not been collected, and so arranged for the company to be deregistered. Subsequent enquiries by the Commissioners showed that a real JD Telecom Ltd invoice differed in form from that used by JD, and the real company had not traded from and was not known at the address given on the JD invoices.

93. The Commissioners maintain, and we accept, that the operations of the defaulting traders exhibited characteristic similar patterns, which we may summarise as follows:

They had registered for VAT between 2003 and 2006, and to have specified an activity in their Forms VAT 1 other than wholesaling trading in mobile phones and CPUs
Their turnover as projected in their Forms VAT 1 was usually significantly, indeed exponentially, higher than that they subsequently declared
The level of turnover increased dramatically in the weeks before the Commissioners discovered their activities to sums out of all proportion to their apparent resources and expertise
They were invariably able to source their products at a price lower than the broker paid them
Their principal place of business was often a residential address or short-term serviced accommodation capable of being vacated at short notice with no significant contribution from the trader
When the Commissioners were alerted to the fact of the traders’ wholesale deals in goods, it was usually as a result of enquiries of freight forwarders or other traders rather than any declaration by the trader itself
On the Commissioners commencing an investigation into the affairs of defaulting traders, the individuals behind those traders failed to produce the business records on request and / or disappeared without making returns, and failed to pay the VAT on their sales
When paperwork was discovered relating to deals carried out by the defaulting company, it was usually incomplete and haphazard
Third party payments by customers of defaulting traders to other parties were common, and left those traders unable to meet their tax liabilities
Invariably, once their activities were discovered, the defaulting traders failed to co-operate with the Commissioners in their requests and inquiries, and failed to account for tax due. Subsequently, they were deregistered and assessed to tax, but took no steps to appeal either deregistration or assessment.

94. We also accept a submission by Mr Benson that, in the circumstances we have described, it is impossible for us to come to any conclusion other than that, when a trader with an outstanding liability for output tax disappeared, or when one trader masqueraded as another, legitimate, trader by hijacking the VAT registration number of the legitimate trader for the purpose of collecting VAT for which it failed to account, the relevant loss was attributable to fraud. We are quite satisfied that the tax losses identified by the Commissioners in the deal chains in which Pharmaquim was involved were connected to the fraudulent loss of VAT.

95. It follows that we find that Pharmaquim’s transactions in respect of which the Commissioners have denied its input tax claims were connected to the fraudulent evasion of VAT elsewhere in its transaction chains.

Question 2: Did Pharmaquim know that its transactions were connected to the fraudulent loss of VAT, or should it have known that they were so connected?

96. Having dealt with the first of the issues before us we then turn to consider the second: did Pharmaquim know that its transactions were connected to the fraudulent loss of VAT elsewhere in its transaction chains, or should it have known that they were so connected?

97. The law we must apply in answering that question is to be found in the ECJ decision in Kittel, and in the very recent decision of the Court of Appeal in Mobilx. In Kittel, the ECJ refused a claim by the appellant company to repayment at the end of an accounting period of the excess of its input over output tax. The questions in that case posited “a recipient of a supply of goods who has entered into a contract in good faith without knowledge of a fraud committed by the seller”. The referring Belgian court also wished to know if the answer of the ECJ would have been different had the taxable person known or should have known that by his purchase he was participating in a transaction connected with the fraudulent evasion of VAT. Having reiterated that a trader’s right to deduct in respect of a transaction was unaffected by other transactions, whether previous or subsequent, the ECJ confirmed at paragraph 51 that “traders who take every precaution which could reasonably be required of them to ensure that their transactions are connected with fraud, be it the fraudulent evasion of VAT or other fraud, must be able to rely on the legality of those transactions without risk of losing their right to deduct the input VAT…” The ECJ then dealt with the converse case stating, inter alia:

a) where the tax authorities find that the right to deduct has been exercised fraudulently, they are permitted to claim repayment of the deducted sums retroactively (para 55);

b) in the same way, a taxable person who knew or should have known that, by his purchase, he was taking part in a transaction connected with the fraudulent evasion of VAT, must be regarded as a participant in that fraud (para 56) that is because in such a situation the taxable aids the perpetrators of the fraud (para 57).

98. The ECJ concluded by determining that “…where it is ascertained, having regard to objective factors, that the supply is to a taxable person who knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, it is for the national court to refuse that taxable person entitlement to the right to deduct” (para 61).

99. In Mobilx, the Court of Appeal considered the Kittel judgment in some detail and, from the leading judgment of Moses LJ, the questions we must ask in reaching our conclusion emerge as:

1) whether Dr Khan, as owner and director of Pharmaquim, exercised due diligence, or did enough to protect Pharmaquim; and

2) “whether he should have known that the only reasonable explanation for the circumstances in which his transaction took place was that it was connected to fraudulent evasion of VAT” (see paras 74 and 75 of the judgment of Moses LJ).

100. At para 111 of his judgment in Red 12 Trading Ltd v HMRC [2009] EWHC 2563 (Ch) Christopher Clarke J explained that:

“…in determining what it was that the taxpayer knew or ought to have known the tribunal is entitled to look at the totality of the deals effected by the taxpayer (and their characteristics), and at what the taxpayer did or omitted to do, and what it could have done, together with the surrounding circumstances in respect of all of them.”

101. Direct evidence of knowledge or means of knowledge is not to be expected, rather we must rely on inferences drawn from primary facts – see for example, Dadourian Group International Ltd v Simms [2009] EWCA 169 (Ch) where, at para 89, the Court of Appeal dealt with a submission to the contrary:

“At times [counsel] came close to suggesting that fraud can only be established where there is direct evidence. If that were the case, few allegations of fraud would ever come to trial. Fraudsters rarely sit down and reduce their dishonest agreement to writing. Frauds are commonly proved on the basis of inviting the fact-finder to draw proper inferences from the primary facts.”

102. We propose first to consider the submissions of Mr Jones, coupled with Mr Benson’s responses to them. Then we shall deal with Mr Benson’s own submissions, before adding a number of our own observations. In that way we shall paint a picture to include the inferences we draw from the evidence, and on which we base our conclusion.

103. In Mr Jones’s submission, the Commissioners’ primary case indicated that each of Pharmaquim’s transactions was “contrived” as part of an overall scheme to defraud the revenue, and it knew that to be the case at the time; their case was that the company was a knowing participant in a criminal conspiracy involving many parties and a high degree of organisation, such that each transaction was part of a scheme with no commercial purpose. He contended that we should not uphold such allegations without compelling evidence that Pharmaquim, through the agency of Dr Khan, was dishonest. In response, Mr Benson observed, correctly in our judgment, that the Commissioners did not need to show that there was an overall scheme to defraud the revenue; they were required only to prove that Dr Khan knew or had the means of knowing that Pharmaquim’s transactions were connected with the fraudulent loss of VAT. We may state our reasons for accepting Mr Benson’s submission quite shortly. As Lewison J observed in para [85] of his judgment in HMRC v Livewire Telecom Ltd and Olympia Technology Ltd v HMRC [2009[ STC 643, in Kittel the ECJ “was at pains to stress that the test was not one of dishonesty”. And, dealing with both knowledge and means of knowledge, we would repeat the extract from para 41 of the judgment of Moses LJ in Mobilx we cited at para [11] above, where the learned judge made plain that traders who do not meet the objective criteria determining the scope of the right to deduct input tax are to be treated as participants in VAT fraud.

104. Then Mr Jones maintained that the evidence of Dr Khan was entirely consistent with Pharmaquim being a careful and honest trader. In support he noted that the company had engaged Rochesters to provide a range of professional accountancy services; that the company acted on all the Commissioners’ recommendations, and maintained comprehensive documentation; that none of its direct counter-parties had gone missing or otherwise defaulted; that all the relevant transactions had taken place before there was any suggestion that any of Pharmaquim’s deal chains had been traced back to a defaulter (an additional fact we find); that the company ceased to trade as soon as it was told that one of its transactions had been traced back to a defaulter (as to which see below); that Dr Khan had throughout been frank and co-operative in his dealings with the Commissioners, and completed Pharmaquim’s paperwork in proper form; and that there was no evidence of complicity on the part of Pharmaquim’s freight forwarders. We accept as true the matters on which Mr Jones relied for his submission, but reject the submission itself: the evidence presented by the Commissioners clearly indicated that Pharmaquim took little, if any, care in its choice of counter-parties, and its action on the Commissioners’ recommendations as to how it should avoid the risk of being drawn into VAT fraud was, in our judgment, for appearance’s sake rather than genuine.

105. The Commissioners’ case was, in Mr Jones’s further submission, based entirely on hindsight, and completely failed to show how the companies with which Pharmaquim dealt were said to have arranged the transactions they required to be carried out to achieve their objectives. Mr Benson challenged those contentions generally and on two specific grounds. His general submission was both a simple rejection of the “hindsight” claims and an indication that the Commissioners were not required to show how transactions were arranged to achieve fraudsters’ objectives. The two specific grounds he relied on were; first, that as early as July 2005 Dr Khan knew that wholesalers would not deal with importers due to the prevalence of fraud in the market and, secondly, that Pharmaquim did not deal with ordinary retailers, they being unwilling to purchase phones in the quantities in which the company was dealing. In our judgment, the evidence clearly showed the Commissioners case not to be based on hindsight, and Pharmaquim’s transactions to have been pre-arranged: it was not for the Commissioners to show how the companies with which Pharmaquim dealt were said to have arranged the transactions concerned.

106. Mr Jones also invited us to judge Pharmaquim’s transactions on the basis of the information available to it when they were carried out: “…the character of a particular transaction in the chain cannot be altered by earlier or subsequent events”, per the ECJ at para 47 of its judgment in Optigen Ltd v Customs and Excise Commissioners [2006] STC 419. He submitted that the Commissioners’ case fell far short of compelling an inference of dishonesty. As we explained above, dishonesty is not the test we must apply. In arriving at our conclusion, we do judge the transactions on the basis of the information Pharmaquim had available to it at the relevant times.

107. Dr Khan had, in Mr Jones’s yet further submission, proved an entirely honest and credible witness. If the market in which Pharmaquim traded was as rife with fraud as the Commissioners suggested, it was credible that the company had been caught up in it, as Dr Khan claimed. Although his attention had been drawn to the fraud, he had not realised on how large a scale it was being committed. Mr Benson rejected those submissions as being unsustainable: Dr Khan admitted that he personally had not carried out most (if not all) of the deals, that task having been delegated to Mr Birdy, and since Dr Khan was well aware of the fact that wholesalers would not trade with an importer, he must have known that fraud in the market was rife. Mr Jones went on to dismiss a suggestion by the Commissioners that there was no role in the grey market for a middle-man such as Pharmaquim, claiming that the wholesale market was not transparent; websites such as IPT did not show the prices of goods on offer so that there was considerable scope for negotiation of prices, leaving room for a newcomer to establish new, profitable, albeit low margin, business relationships. He maintained that the Commissioners had adduced no evidence whatsoever to show that a newcomer into the market, even one with no previous experience in it and totally devoid of capital, could not have succeeded to the extent that Pharmaquim apparently did. We did not find Dr Khan honest or credible: indeed, his evidence as to how Pharamaquim entered the grey market in mobile phones and the apparent ease with which it was able to find a network of suppliers willing to offer it, as a company with no history in the market and no working capital of its own, credit facilities running into millions of pounds, and allowing it to export goods to unidentified customers in unidentified EU countries with no credit arrangements in place, and no guarantee of payment, was incredible. In our judgment, no legitimate trader would have provided Pharmaquim with phones on those terms: the risk of non-payment, or possibly of not seeing the goods ever again, would simply have been enormous and unnecessary. It follows that we too reject Mr Jones’s submissions. The evidence as to Pharmaquim’s entry into the grey market is amongst the most compelling as indicating that Dr Khan, and hence his company, knew that its transactions were connected with VAT fraud.

108. It was common ground that the grey wholesale market in phones existed. In Mr Jones’s submission, it was sizeable and real, and was facilitated by portals such as IPT. Dr Khan had informed the Commissioners of his intention to use that website; there was nothing improper in Pharmaquim doing so, and we should accept that it was a genuine market. Mr Benson submitted that the falseness of Pharmaquim’s position was well illustrated by the fact that the wholesale market had no reason to exist other than to serve the retail one. In our judgment, the evidence that the grey market in which Pharmaquim was dealing was not genuine is also compelling. Every aspect of it contained indications that it was not commercial, was contrived, and the transactions in it were pre-arranged.

109. Mr Benson’s cross-examination of Dr Khan on the question of Pharmaquim having title to goods was, in Mr Jones’s submission, based on an entirely false premise, namely that it could not pass title to goods which it did not own. Mr Jones contended that the arrangement within the market in which Pharmaquim operated provided for title to pass to a customer once goods were released to the supplier and, in each case, Pharmaquim’s supplier had released the goods to it before it, in turn, released them to its customer. As Dr Khan accepted in cross-examination that Pharmaquim did not have title to the goods, in the sense of truly owning them, Mr Benson described his evidence about the transfer of title as “vague and unconvincing”. He submitted that all Dr Khan could have done was to seek permission of its supplier to export goods: if Pharmaquim had had title, Dr Khan need not have sought permission to export. We agree with Mr Benson that it defies logic and commercial reality that each trader in Pharmaquim’s transaction chains was able to, or indeed did, relinquish possession of goods of substantial worth without payment having been made for them, or any security for payment being given. Equally illogical to Mr Benson was Dr Khan’s unsupported claim that, notwithstanding that a supplier retained title to goods pending payment, a trader allocated stock was given permission to export it. And despite not having title to phones, again illogically, each trader continued to trade them until their EU importer behaved atypically, and paid his supplier, whereupon payments cascaded down the chain of transactions and title to the phones correspondingly ascended the chain. The position of the EU importer was, in Mr Benson’s further submission, equally unbelievable and illogical. For no disclosed reason, that trader unilaterally decided to pay its supplier – a risk that no legitimate trader would have taken. We were invited by Dr Khan to believe that the EU importers made payment despite knowing that their suppliers held no title to the phones concerned, and would never do so unless payments made their way through an unknown number of traders. Further, each EU trader allegedly took that risk despite the facts that no other person in the chain had deemed it necessary or acceptable, that there was no identified motive which might have prompted such largesse, and that the industry was rife with fraudsters and missing traders, any one of whom could have prevented title being transferred. As we accept Mr Benson’s submissions as to illogicality, it follows that we too are unable to accept Mr Jones’s submission. In doing so, we should say that, in our judgment, the lack of Pharmaquim’s title to goods it purported to release to customers and their transfer is perhaps the most compelling evidence of all that Dr Khan knew that Pharmaquim was being drawn into transactions involving the evasion of VAT.

110. Mr Jones contended that the company’s business involved it in accepting a degree of commercial risk, a risk that was minimised by its shipping goods abroad “on hold”. In contrast, Mr Benson maintained that Pharmaquim’s business activities involved it accepting no commercial risk in its operations, it being certain that it would be paid for all supplies it made, and not authorising their release until they were paid for. Again, in the light of all the evidence, we accept the submission of Mr Benson: Pharmaquim’s transporting of goods abroad bore all the hallmarks of contrivance and pre-arrangement.

111. Pharmaquim gave and accepted credit, but Mr Jones maintained that it was allowed credit only by suppliers where it was an “established customer” and, in so far as it provided credit to Broadcast, it did so having carried out over 30 successful deals with that company before Broadcast incurred the large debt it was unable to pay. To Mr Benson, Pharmaquim’s involvement with Broadcast illustrated the contrivance the Commissioners alleged: there was no evidence that Broadcast ever had any assets, and the due diligence on that company Pharmaquim had carried out, particularly in the form of the Dun and Bradstreet report, showed it as having a high risk of business failure. Once more, since we agree that there was no evidence of Broadcast ever having had any assets, we are satisfied that there was contrivance. We might also add that were we to accept what we understand to be Mr Jones’s interpretation of “established customer”, it would extend to every trader with which Pharmaquim had carried out one successful transaction. We are not prepared to accept such an interpretation.

112. The arrangements made for payments by customers to and to suppliers by Pharmaquim were subject to delay, and frequently more than one payment was made to discharge a debt and on different dates. Mr Jones claimed those arrangements to be entirely consistent with normal commerce. Mr Benson, on the other hand, maintained that Dr Khan, who knew of the delays, must have found it odd that a customer who had placed an order then required the goods concerned to be shipped abroad immediately only for them to sit in a warehouse pending payment. In our judgment, no trader acting honestly and prudently would have accepted the arrangements we explained in the pre-penultimate paragraph as commercial. Once more they constitute compelling evidence of contrivance and pre-arrangement, of which Dr Khan must have been aware.

113. Mr Jones contended that the back-to-back deals Pharmaquim entered into were the normal way of conducting business in the grey market. Mr Benson, in reply, implicitly accepted that the contention might have had some validity, but observed that since in the instant case all the deals had been back-to-back, seemingly back to the original importer of the goods, they at least gave the appearance of pre-arrangement. There is little in the point to take matters further for us, so that we regard it as neutral.

114. Dr Khan claimed to aim for a 2 – 3 per cent profit margin on Pharmaquim’s broker deals. Mr Jones maintained that that was realistic in the high volume, low margin business in which the company was engaged and in which there was a lot of competition. With Mr Benson we question how someone with no experience of the market, and adding no value to the products, could possibly compete with established traders. In our judgment the evidence of Dr Khan merely served to reinforce the Commissioners’ claims as to artificiality and contrivance in the deals.

115. It was common ground that no mobile phones are manufactured in the UK, so that we accept that all phones sold here are imported. Against that background, Mr Jones claimed the grey market would deal with fluctuations in demand between countries, and that would result in some exports of phones previously imported into the UK. He maintained that the presence of 2-pin plugs on phones being exported to mainland Europe, as was the case in all the transactions with which we are concerned, was entirely consistent with the operation of the grey market. Mr Benson observed that when Nokia imported phones into the UK in the “white” market, they all had 3-pin plugs. The presence of 2-pin plugs in all the phones in Pharmaquim’s transactions indicated that they had either been imported on the grey market, or someone had changed the plugs on them. He submitted that such changes would have been made only had a trader had been selling to the European market; he would have been the only person wanting to make the change. The existence of 2-pin plugs proved that the phones had been imported on the grey market, and were intended for export. We are unable to accept Mr Jones’s submission for the reasons advanced by Mr Benson.

116. We accept a claim by Mr Jones that Pharmaquim properly accounted for the output tax on the one importer transaction it carried out, but find it unnecessary to deal with his further claim that Pharmaquim was not a contra-trader, as that expression is conventionally used. Any attempt at concealment of the transaction would in any event have been pointless as Dr Khan was well aware that the supporting documentation would have to be supplied to the Commissioners. We regard this as yet another submission that is of little help in reaching our conclusion.

117. As to means of knowledge, Mr. Jones submitted that there were three sub-questions, namely:

i) Was Pharmaquim put on notice by matters within its own knowledge such that it should have known that its transactions were connected with the fraudulent evasion of VAT?

ii) Did Pharmaquim take every precaution that could reasonably be expected of it to satisfy itself that the transactions which it was effecting did not result in its participation in tax evasion?

iii) If it did not take every such precaution,

a. what further precautions should it have taken; and

b. would it have discovered the connection, if any, with fraud had it taken those precautions?

118. In so far as the Commissioners alleged that Pharmaquim “should have known”, Mr Jones relied on the analogy with constructive knowledge accepted by Lewison J in Livewire Ltd v Revenue and Customs Commissioners [2009] STC 643 as a presumption so strong of the existence of the knowledge “that it cannot be allowed to be rebutted”. We are content to proceed as Mr Jones suggested.

119. If a default post-dated the relevant transaction, or involved a hijacked VAT number, Mr Jones submitted it was difficult to see how Pharmaquim either could or should have known anything about the fraud at the time of the relevant transactions. And, in the instant case, since the alleged defaults all took place after Pharmaquim’s transactions, as a matter of logic it could only be said of any particular facts or factors that Pharmaquim should have known of the alleged connection if it was clear how the company should have known of that connection by reason of such facts or factors.

120. At para 62 of his judgment in Mobilx Moses LJ stated:

“The principle of legal certainty provides no warrant for restricting the connection, which must be established, to a fraudulent evasion which immediately precedes a trader’s purchase. If the circumstances of that purchase are such that a person knows or should know that his purchase is or will be connected with fraudulent evasion, it cannot matter a jot that the evasion precedes or follows that purchase. That trader’s knowledge brings him within the category of participant. He is a participant whatever the stage at which the evasion occurs.”

121. In our judgment, the whole of the information available to Pharmaquim was such that it, in the form of Dr Khan, must have known of the connection. No company without assets or working capital could possibly have legitimately increased its turnover from virtually nothing to £225 million in a period of just over 12 months: such an exponential increase in those circumstances could only be explained by Pharmaquim being involved in fraudulent trade, as Dr Khan must have been aware.

122. Mr Jones submitted that there was nothing in the material before the tribunal which could or should have alerted Pharmaquim to the existence of the particular frauds on which the Commissioners relied, if such frauds were to be proved. The exaggerated claims contained in some of the introduction letters would not have alerted Pharmaquim to the existence of fraud by the missing trader at the head of the chain, nor would the low credit ratings of its suppliers and customers. Mr Benson rejected the last mentioned submission maintaining that it should have put Pharmaquim on warning: according to Dr Khan the market operated on the basis that traders offering credit to Pharmaquim provided it with the opportunity to make the greatest profit of all those in the deal chains. That indicated that either credit was too easily granted to Pharmaquim, or someone else in the chain was stupid enough to give credit to Pharmaquim’s supplier, which had no credit rating. We observe that it is unnecessary for the Commissioners to demonstrate that Pharmaquim knew, or had the means of knowing, any of the precise details of the fraud: it is sufficient that it knew that the transactions into which it entered were “connected with” fraud. In our judgment, the information Pharmaquim had clearly showed its transactions to be connected with VAT fraud, and Dr Khan to have known of the connection.

123. In each of the 19 deals carried out by Pharmaquim in period 06/06, it went to some lengths to source and order the mobile phones in the course of one day, and the deal packs showed that each trader in each chain purchased and sold phones on the same day. However, as noted by Mr Benson, the “fast moving and dynamic market” described by Dr Khan did not extend to payment for phones; payment was often made some time after deals took place, and goods were not released to purchasers until payment was made. And even where payment for goods was made to Pharmaquim, there was often a delay in the company making payment to its supplier. In our judgment, no genuine supplier would have been prepared to trade with Pharmaquim on such a basis – a matter of which Dr Khan must also have been aware.

124. We accept a submission by Mr Jones that Phamaquim ceased trading as soon as it was informed by the Commissioners that a transaction within one of its deal chains was alleged to be tainted, although the deal in question did not involve one of he company’s counter-parties. However, in isolation that takes matters no further.

125. That completes our consideration of Mr Jones’s submissions, and we move on to deal with those of Mr Benson. In the absence of fraud, the latter contended that, as no legitimate trader would have traded under Pharmaquim’s trading model, we were entitled to conclude that had Dr Khan properly considered the model adopted, he would inevitably have suspected, indeed almost certainly concluded, that the transactions in which Pharmaquim was involved in were both contrived and connected to fraud: Dr Khan offered no explanation as to why such clear indicators of fraud had been ignored. We accept that contention unreservedly.

126. Dr Khan totally ignored the negative indicators its due diligence on both its suppliers and customers revealed. We agree with Mr Benson that Dr Khan’s claim to rely entirely on the fact that goods were transported abroad “on hold” pending payment by the customer provided Pharmaquim with adequate protection against non-payment by the customers did no such thing.

127. Mr Benson further maintained that no legitimate trader would have provided mobile phones worth hundreds of thousands of pounds to another trader without payment knowing that it would be paid only if every trader involved in subsequent transactions in the same goods at each link in a chain of unknown length made payment. We agree. In our judgment, Mr Benson’s submission applies a fortiori where, on Pharmaquim’s case, the true owner of the goods would not have been aware of the identity of the subsequent traders in the chain or even the country of residence of the EU trader eventually making payment. Again, we agree with a submission of Mr Benson that it is impossible to believe that such a remarkable show of trust would have existed between legitimate traders where locating the goods after they had moved through numerous chains would either have been impossible or virtually impossible.

128. Further, in the “profitable and vibrant industry” described by Dr Khan, Mr Benson contended that it would have been at least likely that a trader such as Pharmaquim could have sold phones to a cash purchaser, or increased its profits, by shortening its supply chains. In his further submission, which once more we accept, Pharmaquim’s trading model presupposed a trader at the beginning of the chain holding valuable goods which did not seek to maximise its profits by selling as close to the consumer as possible, and which was willing to take an enormous and unnecessary risk that it would never receive payment, or see the goods. Mr Benson noted that in every sale transaction, except Deal 1, Pharmaquim released goods to its customer before it paid its own supplier.

129. Mr Benson also observed that it was unlikely that any legitimate trader would have wished to trade with a company such as Pharmaquim that did not require a detailed specification of phones being traded to be set out in the paperwork, indeed did not want to commit to an exact specification. Such behaviour, he submitted, would have left the company at risk of acquiring handsets not adequately specified to meet customer requirements. Yet again we accept the correctness of that submission, and as one more indicator of Pharmaquim knowingly being drawn into VAT fraud.

130. Dr Khan’s account of the inspection of phones was dismissed by Mr Benson as implausible. We agree with the latter’s that, given the large number of phones involved in Pharmaquim’s deals, it was likely to have taken significantly longer than the 3 hours Dr Khan claimed it took to inspect each consignment: as Mr Benson claimed, Dr Khan’s claim that the people carrying out the inspections were “very fast” is simply absurd.

131. There are numerous other facts and factors not the subject of specific submissions that we also take into account in reaching our conclusion, some of which overlap the submissions of counsel, and we shall now deal with them.

132. We earlier dealt at some length with the due diligence carried out by Pharmaquim. It illustrated that such steps as Dr Khan claimed to have taken to protect Pharmaquim from being drawn into transactions connected with fraud were totally inadequate. In our judgment, the steps taken were superficial in the extreme, and again were undertaken for the sake of appearance rather than as true due diligence. As examples of such inadequacy and superficiality, we would cite the facts that, in its dealings with Xcel, Pharmaquim took no action whatsoever when faced with evidence that Xcel’s VAT registration certificate revealed its trade classification as selling and maintaining motor cycles, that it did not make a Redhill check on Xcel until after the first deal between the two companies had been completed, that Dun and Bradstreet’s report indicated that it had been unable to obtain sufficient information on Xcel to enable it to make a credit risk assessment, and that the trade references Xcel offered were not taken up until many months after trading commenced. Our earlier findings clearly illustrate that Pharmaquim behaved similarly in dealing with its other suppliers.

133. Pharmaquim did not record IMEI numbers, such numbers being unique to individual phones and thus being capable of indicating whether they had been dealt with previously or have been stolen. The recording of such numbers would have been one of if not the most important checks Pharmaquim could have made to ensure that its transactions were not connected with VAT fraud. A wholesaler’s failure to record them removes an essential source of evidence as to the origin, destination and the intermediate routes phones may have taken. In failing to record IMEI numbers, we consider Pharmaquim not to have carried out an essential check on the integrity of its supply chains.

134. Additionally, Dr Khan could have enquired of the various freight forwarders it instructed whether the phones in which it dealt had been imported and, if so, how long they had been in the UK. That too represented a failure by Pharmaquim to check the integrity of its supply chains.

135. It is a feature of MTIC fraud that all transactions are carried out in sterling, as was the case with all Pharmaquim’s transactions. That fact takes matters little further in the instant case, but warrants recording.

136. Despite the high value of the transactions into which Pharmaquim entered, it did not enter into written contacts. Written contracts would deal with matters such as the transfer of title, payment and delivery terms, and address the position in the event of goods proving faulty or being returned. The absence of contractual documentation is one more indicator to us that Pharmaquim was not dealing on ordinary commercial terms with its suppliers and customers.

137. Dr Khan made no claim that damaged or faulty stock was ever returned to Pharmaquim, or that stock was damaged in transit, or during loading or unloading. In view of the high number of Pharmaquim’s transactions and the volume of goods traded, we regard it as unusual to say the least that such events never occurred, and we should have expected Dr Khan to have mentioned examples in evidence.

138. In Mobilx at first instance, [2009] STC 1107 Floyd J agreed with counsel for both parties that Notice 726, “Joint and several liability”, was generally “equally applicable to the avoiding of challenges to repayment of VAT”. That Notice contains indicitors of possible involvement in VAT fraud such as companies having only recently been formed, having a high failure risk, and an absence of a credit rating. All those indicators were present in the companies with which Pharmaquim dealt, in most cases in one combination or another. Their presence was apparently completely ignored; provided transactions satisfied the trading model described by Dr Khan, they were carried through by Pharmaquim. In our judgment, in ignoring the indicators, Pharmaquim clearly demonstrated that its due diligence was superficial and designed mainly to give the impression that the company was taking proper precautions. It is yet more compelling evidence of Pharmaquim being knowingly drawn into VAT fraud.

139. Although the test at para 61 of Kittel refers to checks on suppliers, checks on customers are equally relevant in determining whether a trader has taken all reasonable measures to avoid participation in VAT fraud. As we mentioned earlier, Pharmaquim obtained no bank references, business plans or annual accounts from any of its customers. Credit and other financial checks carried out in the context of commercial transactions, whether or not such transactions involve a customer paying in full before goods are released to it, are valuable independent measures of a company’s financial strength, and indicate its ability to conduct legitimate trade on ordinary commercial terms. Further, the checks Pharmaquim failed to carry out were intended to ensure that it was not involved in transactions connected with VAT fraud.

140. A customer paying cash is not the only matter a cautious and vigilant vendor should take into account. He will also wish to assure himself that his customer can and will pay before committing himself to a purchase to satisfy that customer’s specific order. Pharmaquim was altogether too eager to place purchase orders with its various suppliers without having any assurance that it would itself be paid for goods ordered, or without obtaining any payment guarantee. In our judgment, Dr Khan, with knowledge of the considerable risks of fraud contained in the mobile phone market, was much too ready, without a careful and detailed review and the carrying out of exhaustive checks of all aspects of the proposed transactions with its customers, to commit Pharmaquim to them: the information the company had about all its customers was such that it knew it was being drawn into transactions connected with VAT fraud.

141. The situation with regard to Pharmaquim’s suppliers was little different from that of its customers. The Dun and Bradstreet reports Pharmaquim obtained on the former showed that in every case but one there was insufficient information available to enable it to assess the credit risk, and in the remaining one the recommendation was to deal in nothing larger than four-figure sums. In those circumstances, the fact that in every case Pharamaquim dealt in six- and seven-figure sums speaks for itself. So too does the fact that the company effectively ignored the trade references its suppliers provided. Again Dr Khan must have been aware that in dealing with its suppliers it was being drawn into transactions connected with VAT fraud.

142. He must also have been aware that none of its suppliers carried out due diligence on Pharmaquim for, had they done so, they would have had to apply to him for information required for the purpose. That too should have indicated to him that Pharmaquim was not involved in the ordinary commercial market.

143. Nor did Dr Khan query why Pharmaquim’s suppliers made such attractive offers of credit. Any trader in the ordinary commercial market would have expected questions to be put to it to ensure that it was a suitable trader to which to grant credit. In their absence Dr Khan ought to have concluded that Pharmaquim was in danger of becoming involved in transactions that were connected with fraud.

144. Notwithstanding that it was dealing in large numbers of phones, Pharmaquim appears to have had no problem in sourcing the phones its customers required. As we explained earlier, in every broker transaction it obtained the required quantity and dispatched it abroad the same day as it received the customer’s purchase order. That too was, in our judgment, an indicator that the company’s deals were uncommercial. We are satisfied that, as submitted by Mr Benson, Pharmaquim’s trading model was devoid of commercial reality, and the model itself would have put any reasonable businessman on notice that it was not involved in legitimate trade.

145. In our judgment, the due diligence and other checks Dr Khan carried out were casually undertaken, and negative indicators ignored, because in truth both were unnecessary. He knew perfectly well that Pharmaquim’s suppliers and customers would not fail in their obligations for the transactions were pre-arranged and contrived.

146. Our overall conclusion, based on Pharmaquim’s admitted knowledge of the prevalence of fraud in the wholesale phone market, the deficiencies we have identified in its due diligence, and its failure to take the necessary precautions in dealing with its suppliers and customers, is that Dr Khan did not take every reasonable precaution required of him to ensure that Pharmaquim’s transactions did not involve it in participation in VAT evasion. Applying para 61 of the Kittel judgment, that finding is justification for our holding that Dr Khan “…knew that, by his [i.e. Pharmaquim’s] purchase, he was taking part in a transaction connected with the fraudulent evasion of VAT”. The high standard required of a trader meant that Pharmaquim was under a positive duty to take precautions, including the carrying out of due diligence and other checks when indications of risk were presented to it. The Commissioners have proved that Pharmaquim’s state of knowledge was such that its purchases were outside the scope of the right to deduct input tax (see para 81 of the judgment of Moses LJ in Mobilx).

147. However, if we are wrong in concluding that Pharmaquim had actual knowledge of its involvement in VAT evasion, an “ought to know” case will suffice. The Commissioners have satisfied us that Dr Khan should to have known that in carrying out its various transactions, Pharmaquim was involved in the fraudulent of evasion of VAT; the only reasonable explanation for the circumstances in which the company’s transactions took place was that they were connected to fraud.

148. It follows that we dismiss the appeal in its entirety and, since both parties made application for costs in the event of their being successful in the appeal (the case proceeding in the complex category), we direct that Pharmaquim pay the Commissioners’ costs of and incidental to and consequent upon the appeal, such costs to be assessed by a costs judge of the High Court in the event of their not being agreed.

149. We should add that following delivery of the judgments of the Court of Appeal in Mobilx, we invited both parties to make any further submissions they considered appropriate. Both parties responded to our invitation, and we record that our decision takes into account their further submissions.

The Appellant has a right to apply for permission to appeal against this decision in accordance with rule 39 of the Rules. 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.

DAVID DEMACK

JUDGE

Release Date: 11 June 2010

Deal	Invoice	Date of Deal	Date of Inspection	Date of payment to Pharmaquim	Date of Release Note	Date of Payment by Pharmaquim to Supplier	Date of release by EU customer
1	328a	11.04.06	11.04.06	18.04.06 19.04.06	19.04.06	18.04.06 19.04.06
2	336	19.04.06	19.04.06	26.04.06	27.04.06	26.04.06 28.04.06
3	337	19.04.06	19.04.06	28.04.06	28.04.06	28.04.06
4	338	19.04.06	21.04.06	28.04.06	28.04.06	28.04.06 02.05.06
5	340	20.04.06	02.05.06	02.05.06	02.05.06	02.05.06 09.05.06 22.05.06	21.04.06
6	341	20.04.06	20.04.06	21.04.06 09.05.06	10.05.06	21.04.06 22.05.06	24.04.06
7	355	09.05.06	09.05.06	26.05.06	26.05.06	26.05.06 06.06.06
8	356	09.05.06	09.05.06	26.05.06	26.05.06	26.05.06
9	357	09.05.06	09.05.06	22.05.06	26.05.06	06.06.06 10.07.06
10	392	19.05.06	undated	22.05.06	23.05.06	22.05.06 24.05.06	16.05.06
11	393	19.05.06	undated	24.05.06	25.05.06	24.05.06 10.07.06	16.05.06
12	394	19.05.06	undated	24.05.06 26.05.06	26.05.06	26.05.06	16.05.06
13	404	30.05.06	30.05.06	01.08.06 02.08.06	10.07.06	01.08.06 02.08.06
14	405	30.05.06	30.05.06	02.08.06 03.08.06	07.08.06	02.08.06 03.08.06
15	406	30.05.06	30.05.06	06.06.06	06.06.06	10.07.06 11.07.06
16	409	13.06.06	13.06.06	10.07.06	10.07.06	O2 Top up Vouchers
17	410	13.06.06	13.06.06	10.07.06	10.07.06	08.08.06 18.08.06
18	411	13.06.06	13.06.06	04.08.06	07.08.06	04.08.06
19	412	28.06.06	undated	10.07.06	10.07.06	11.07.06
20	413	28.06.06	undated	11.07.06	11.07.06	11.07.06

Deal	Inv No.	Date 2006	Phones	Defaulter	Supplier	Price	Customer	Price (£)	Mark-up (%) achieved
1	328a	24-Mar	5000 N9500	Euro Imports	Xcel	308	URTB	280	-9.09
2	336	19-Apr	3875 MV3X	Apollo	Xcel	208	URTB	212.25	2.04
3	337	19-Apr	2450 N9300i	Apollo	Futuristic	316	URTB	322.25	1.98
4	338	19-Apr	1770 N8800	Apollo	Broadcast	411	URTB	419.25	2.01
5	340	20-Apr	2500 N8801	Apollo	Mana	539	Sigma	549.25	1.99
6	341	20-Apr	5000 N9500	Apollo	Xcel	283	Sigma	288.75	2.03
7	355	09-May	3200 MV3X	SS	Xcel	215	URTB	217.25	1.05
8	356	09-May	920 S W800i	SS	High Speed	155	URTB	156.5	0.97
9	357	09-May	2100 N93001	SS	High Speed	310	URTB	313	0.97
10	392	19-May	6000 N80	Isales	High Speed	366	Sigma	373.25	1.98
11	393	19-May	4000 N91	Isales	Xcel	408	Sigma	416.25	2.02
12	394	19-May	7000 S W810i	Isales	Xcel	260	Sigma	265.25	2.02
13	404	30-May	5000 N8800	Udeil	High Speed	409	GTC	399	-2.44
14	405	30-May	7000 N9300i	Udeil	Xcel	326	GTC	317	-2.76
15	406	30-May	2500 S W810i	Udeil	Xcel	230	GTC	219	-4.78
16	409	13-Jun	2350 N9300i	Universal	Xcel	279	GTC	290	3.94
17	410	13-Jun	1200 N8800	Universal	Export Co.	340	GTC	353.75	4.04
18	411	13-Jun	550 N8801	Universal	Xcel	380	GTC	395.25	4.01
19	412	28-Jun	5000 N E70	JD Telecom	Xcel	280	GTC	291.25	4.02
20	413	28-Jun	4000 N N91	JD Telecom	Xcel	312	GTC	324.5	4.01

First-tier Tribunal (Tax)

PHARMAQUIM LTD Appellant

THE COMMISSIONERS FOR

HER MAJESTY’S REVENUE AND CUSTOMS Respondents

Richard Jones QC and Willian Hansen for the Appellant

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You are here: BAILII >> Databases >> First-tier Tribunal (Tax) >> Pharmaquim Ltd v Revenue & Customs [2010] UKFTT 279 (TC) (11 June 2010) URL: http://www.bailii.org/uk/cases/UKFTT/TC/2010/TC00568.html Cite as: [2010] UKFTT 279 (TC)