Due diligence and risk assessment: Observations by the courts
The Court of Appeal
The Court of Appeal, in its judgment in the case of Mobilx Ltd (in administration) and others ( EWCA Civ 517), stated:
- A trader who decides to participate in a transaction connected to fraudulent evasion, despite knowledge of that connection, is making an informed choice; he knows where he stands and knows before he enters into the transaction that if found out, he will not be entitled to deduct input tax. The extension of that principle to a taxable person who has the means of knowledge but chooses not to deploy it, similarly, does not infringe that principle. If he has the means of knowledge available and chooses not to deploy it he knows that, if found out, he will not be entitled to deduct. If he chooses to ignore obvious inferences from the facts and circumstances in which he has been trading, he will not be entitled to deduct.
The court also made clear that too much emphasis should not be placed on due diligence / risk assessment by Tribunals when judging whether or not a taxable person ‘should have known’ his transactions were ‘connected with fraudulent evasion of VAT’:
- Even if a trader has asked appropriate questions, he is not entitled to ignore the circumstances in which his transactions take place if the only reasonable explanation is for them is that his transactions have been or will be connected to fraud. The danger of focussing on the question of due diligence is that it may deflect a Tribunal from asking the essential question posed in Kittel, namely, whether the trader should have known that by his purchase he was taking part in a transaction connected with fraudulent evasion of VAT. The circumstances may well establish that he was.
The High Court
The High Court, in its judgement in the case of Mobilx Ltd (in administration) ( EWHC 133 (Ch)) stated:
Of course, an otherwise innocent trader can only do so much to ascertain whether its supply line is “clean” or “dirty” (to use the expressions used in MTIC fraud cases). It can make enquiries of its immediate supplier, including enquiries as to the diligence with which its immediate supplier checks, in turn, on its supplier. Beyond that, the immediate supplier cannot as a matter of commercial reality be expected to reveal the identity of its own suppliers without risking being cut out of the business.
In the light of the difficulties of making enquiries beyond the immediate supplier, there is a danger in reading para 51 of Kittel in a narrow sense and as suggesting that provided proper checks are carried out by the trader on a supplier, then the trader’s claims to repayment of VAT are not capable of challenge. That is not, in my judgment, a correct view. Suspicious indications obtained by a trader from carrying out due diligence checks on its supplier are one, but not the only basis from which it may properly be inferred that a trader knew or should have known of its implication in VAT fraud. The test to be applied is that set out in para 61 of the Judgment, and indeed in the court’s final determination at the end of the judgment. Paragraph 51 needs to be understood in the sense that “all reasonable precautions” may, in some cases, involve ceasing to trade in specified goods in a particular market, at least in the particular manner in which the trader undertakes that trade. Such a situation may conceivably arise where, from other indications available to the trader, the trader knew or should have known that it is more likely than not that, despite all due diligence checking, any further goods traded in the same way will be implicated in VAT fraud.