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Bond House was a dealer in computer components. A significant part of its business comprised the purchasing of CPUs from traders registered for VAT in the UK and the selling of CPUs to traders registered for VAT in other member states. Bond House’s repayment of significant amounts of input VAT was refused by HM Revenue and Customs (HMRC). Similarly, Optigen and Fulcrum were traders, mainly in computer chips, who purchased in the UK and sold to customers located in other member states. They became innocent parties in a number of transactions comprising a carousel fraud; HMRC declined their VAT returns.

HMRC contended that the relevant purchases and sales were “devoid of economic substance”. Accordingly, the purchases were not supplies used or to be used for the purposes of a business and the sales were not supplies made in the course of a business for the purposes of VAT. That approach was upheld by the VAT and Duties Tribunal in the Bond House and Optigen and Fulcrum cases. The tribunals held that where there is a chain of purchases and sales of particular goods around a circle of traders and one of those traders (the “Missing Trader”) disappears without accounting for acquisition VAT (which he is obliged to pay on importing goods into the UK from another EU member state), then none of the purchases and sales can be said to amount to an “economic activity”, as that phrase is used in Article 4(2) of the Sixth Directive. Consequently, the exporter in the UK cannot recover the “input tax” that he was charged by his supplier, because it was not input tax. The underlying questions of community law – whether transactions such as those at issue qualify as economic activities within the meaning of Article 4(2) of the Sixth Directive and whether, in order to make this assessment, regard should be had to the chain of transactions as a whole or to each transaction individually – were referred to the European Court of Justice (the ECJ).

On 16 February 2005, Advocate General Maduro released his opinion. He said that HMRC’s approach gave rise to considerable uncertainty concerning the application of the Sixth Directive: “If traders wanted to be sure at the time of a transaction that they were incurring rights and obligations under the VAT system, they would have to predict whether the specific goods which were the subject of the transaction would at some point fall back into the hands of a trader who had already played a part in the supply chain. If that were to be the case, they would also need to know about any subsequent ‘disappearance’ on the part of that trader.” He criticised HMRC’s approach and said that it might “act as a deterrent to legitimate trade.”

On 12 January 2006, the European Court of Justice (ECJ) delivered its judgment in the joined cases of Optigen Limited, Fulcrum Electronics Limited and Bond House Systems Limited. The ECJ took a similar line to the Advocate General. The ECJ held that transactions, which are not themselves vitiated by VAT fraud, constitute supplies of goods or services within the meaning of the Sixth Directive, regardless of the intention of a trader other than the taxable person concerned involved in the same chain of supply: “The right to deduct input VAT of a taxable person who carries out such transactions cannot be affected by the fact that in the chain of supply of which those transactions form part of another prior or subsequent transaction is vitiated by VAT fraud, without that taxable person knowing or having any means of knowing.”

 Can the VAT that HMRC withheld be reclaimed on the basis of “non-economic activity”?

Business Brief 01/06 was published on 18 January 2006. In it, HMRC states that “all cases in which assessments have been raised or input tax claims reduced on the [Bond House] principle are being reviewed in the light of the ECJ’s guidance.”

In addition, HMRC confirmed that “where a repayment that had been disallowed is reviewed…and now found allowable, HMRC is legally obliged to pay repayment supplement for the period of delay whilst awaiting the ECJ decision.”

Can interest and costs be recovered?

Although s78(2) Value Added Taxes Act 1994 (VATA) provides that a payment of repayment supplement under s79 precludes a payment of interest under s78, there is scope for claiming interest under s84(8), VATA. Potentially, legal costs can also be claimed. The answer as to whether interest and costs are payable will depend on the facts of each individual case.

 Can damages be recovered from HMRC?

Since the decision of the ECJ in Francovich, it has been clear that member states (and emanations of member states, such as HMRC) are capable of being held to account in damages for breaches of community law that cause loss to, for example, taxpayers. The ECJ case of Brasserie du Pêcheur sets out the basis on which a state can be liable to pay damages to a taxpayer. In the light of that case, the key factor will be the extent to which HMRC was entitled to rely on the decision of the tribunal in Bond House Systems in enforcing its “non-economic activity” approach, given that there was significant doubt as to the correctness of that decision and that it was known that this approach was causing significant damage to the industry. There is a strong argument that the administrative regime adopted by HMRC for dealing with claims for input tax can itself be shown to have caused loss.

 What will making a claim for damages entail?

The first step is to file a claim at the High Court. In broad outline, the basis of the claim is that HMRC has acted unlawfully with regard to its “business disruption” philosophy and regime of the denying repayments of input VAT and the raising of assessments on innocent traders to recover input tax already paid. HMRC’s approach has affected a significant number of businesses; and because of the number of potential claimants, it is likely that the High Court will require the various claims to be managed by way of a Group Litigation Order (GLO). A GLO is a mechanism that enables the efficient case management of multiple claims that give rise to common or related issues of fact or law. Under a GLO, a test case is taken forward in order to determine all the common issues, and the remaining claims are stayed. Each party to the GLO contributes to the costs incurred by the test claimant in relation to the test claim. Thus, the costs (and risk) are shared by the GLO claimants.

If a business simply waits until resolution of this matter in the GLO, HMRC may try to rely on time limits in order to deny compensation. It is important therefore to ensure that any claim is protected. It is only by making a claim in the High Court that this can be achieved.

Simon Boon, tel: 020 7796 6542,
and Hartley Foster, tel: 020 7153 7101,
DLA Piper Rudnick Gray Cary UK LLP

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