Innova Inc (UK) v Customs and Excise [2005] UKVAT V18989 (22 March 2005)

18989
VALUE ADDED TAX — cancellation of registration — determination by Commissioners that registered person not engaged in business — dealer in mobile telephones — whether “business” a sham — nature of tribunal’s jurisdiction — supervisory — whether decision to cancel registration and refusal to reinstate it reasonable — yes — appeal dismissed 

MANCHESTER TRIBUNAL CENTRE

 
 	
	INNOVA INC (UK) LTD	Appellant

	- and -

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	Respondents

				Tribunal:	Colin Bishopp	 (Chairman)
						Rayna Dean		

Sitting in public in Birmingham on 20 January 2005 and in Manchester on 25 January 2005

Nicola Preston, counsel, instructed by VATease, for the Appellant
James Puzey, counsel, instructed by the Solicitors office of HM Customs and Excise for the Respondents

	© CROWN COPYRIGHT 2005

DECISION
1.	In this appeal, Innova Inc (UK) Ltd (“Innova”) challenges the Respondents’ decision, made on 21 January 2004, to cancel its VAT registration with immediate effect. Innova is aggrieved too that the Respondents have refused to reinstate its registration, or to register it afresh, but the parties agreed that the two matters are dependent on identical factors, and that the facts and the law we must consider are the same in each case. As an urgent decision was requested we announced at the end of the hearing, without giving reasons, that the appeal would be dismissed. We now set out our reasons.
2.	The Appellant was represented by Nicola Preston of counsel and the Respondents by James Puzey, also of counsel. We heard oral evidence from Innova’s only director, Gregory Warren, and from the Customs officer whose decision it was to cancel the registration, Allan McClelland. We were provided with a number of documents.
3.	It was common ground that Innova was registered for VAT, at its own request, with effect from 2 August 2002. Curiously, it described itself in the application for registration (completed by Mr Warren) as “Innova (UK) Ltd”, but the error was corrected in October 2003. (Even then, although the Companies Registry records show the correct name as Innova Inc (UK) Limited, Mr Warren’s stationery also uses the names Innova Inc UK Limited and Innova (Inc) UK Limited). Mr Warren told us he had simply made a mistake when completing the application, and emphasised that he had given, correctly, the number allocated by the Companies Registry when Innova was incorporated. We accept that, in this, he did not set out to deceive. The application gave a trading address in Nottingham, and described Innova’s business, or at that stage intended business, as “Wholesale of optical products & ancillary products, sunglasses etc”.
4.	When he sought registration for Innova, Mr Warren told us, he was still a director of another company, New Jersey Optical Co, which was trading, though it was clearly not doing well as it entered into liquidation in October or November 2002. Mr Warren had acquired Innova, he said, so that he could carry on much the same business by means of another corporate vehicle. Although New Jersey Optical Co, as its name suggests, was in the optical trade, it had dealt, Mr Warren said, in mobile telephones on four occasions before it went into liquidation. We mention in passing that, although Mr Warren was actively engaged on New Jersey’s business in May 2002, when Innova’s registration application was completed, he had answered the question on the application, “Are you or any of the partners or directors in the business you are seeking to register through this application, involved in running any other business either as a sole proprietor, partner or director?”, and the similar question asking about such involvement in the preceding two years, in the negative. Mr Warren was unable to offer any explanation of those errors. We have concluded that he must have known that his replies were untruthful.
5.	In about March 2003 Innova notified the Commissioners that its address was now in York. Shortly afterwards – apparently because the Appellant had not been rendering VAT returns – the Commissioners began to correspond with Mr Warren about an intended visit at which they proposed to inspect the Appellant’s business records. Mr Warren was evidently reluctant to meet Customs officers, at least in the manner they wished, but he did answer a number of questions which were put to him in the correspondence.
6.	The intended meeting did not take place, but Mr Warren offered to copy all the records and leave them at the York VAT office. Mr McClelland, who by December 2003 was dealing with the matter for the Respondents, agreed to that course. He collected those records Mr Warren had left at the York office on 19 January 2004 and, he said, examined them the next day. He found them in what he described to us as poor order, and he considered them to be incomplete. Mr McClelland decided that his best course was to make an unannounced visit to Innova’s premises in York, and he did so on 21 January 2004. He found that they were in an apartment building. The letterbox on Innova’s premises had been sealed. He made enquiries of the concierge who, he said, told him that Mr Warren had left before Christmas, leaving no forwarding address although the concierge understood he was in the West Midlands.
7.	Although he was imprecise about the date of his move, Mr Warren agreed that he had left the York address in December 2003, and had then traded from an address in Birmingham. He maintained that he had informed the Commissioners of his move by putting a note to that effect with a VAT return he had rendered, though he could not recall when he had done so, and he had not kept a copy of the note.
8.	We have no doubt that contention is false. It is true that in a letter dated 25 November 2003 Mr Warren had mentioned an intention to relocate to the Midlands “in the not too distant future”, but nothing else is consistent with his claim that he notified the Commissioners of Innova’s change of address. Mr Puzey was able to show that no VAT returns had been rendered between October 2003 and January 2004. On 23 December 2003 Mr Warren wrote from the York address, making no mention of any move which had already occurred, or which was about to occur. Other documentation makes it clear that in January 2004 Innova was still using the York address on its invoices and on other documents it exchanged with its suppliers and customers. In January 2004 Mr Warren had Innova’s records taken by courier from Birmingham, where he was then located, to York in order that Mr McClelland, who (to Mr Warren’s knowledge) was based in Sheffield, could travel there to collect them. If Mr Warren had, as he maintained, already advised the Commissioners of his move, there could be no possible reason why he did not instead deliver the records to Sheffield or, if he preferred, to a VAT office in Birmingham. We are satisfied that Mr Warren was attempting to conceal his, and Innova’s whereabouts from the Commissioners; there is no other plausible explanation of his conduct.
9.	Mr McClelland was aware that Innova was dealing in mobile telephones, a trade which Customs consider presents a significant risk to the revenue, and he formed the view from Innova’s having left its York premises without leaving a forwarding address that it might have become a “missing trader”, that is a trader which disappears while indebted to the Commissioners. Innova, according to the Commissioners’ records, owed them over £33,000. Fearful that it might continue to trade, he decided to cancel its VAT registration immediately. Since dealers in mobile telephones will trade only with other dealers who have valid VAT registrations (not least because only by doing so can they comply with Customs’ code of practice and obtain some, if limited, protection from dishonest dealers) cancellation of Innova’s registration would prevent it from trading and incurring an ever-increasing liability for output tax. We comment at this point only that we consider Mr McClelland’s actions were quite reasonable, in the light of what he then knew.
10.	It was, of course, incumbent on Mr McClelland to notify Innova of his decision. He sent a letter by fax to the York number which Mr Warren had previously provided. It provoked an immediate response; as Mr Warren confirmed when he gave his evidence he had arranged for his telephone and fax calls to be diverted. Mr Warren sent a fax to Mr McClelland , which disclosed Innova’s new address and contained the claim that notification had already been given. The fax went on to protest, in vigorous terms, about the cancellation of Innova’s registration, but Mr McClelland was unmoved. Shortly after, Mr Warren agreed to a meeting, which took place on 6 February 2004, at Innova’s Birmingham address. Mr McClelland attended with another officer, and Mr Warren had the assistance of a VAT adviser. We had a note of the meeting, made by Mr McClelland, the detail of which was not agreed although it was accepted as a fair record of the topics discussed. Mr McClelland asked a large number of questions about the nature of Innova’s activities, its management, its accounting practices and policies, and various other matters. The note shows that Mr Warren refused to answer several questions. He did so, he told us, because he had been advised by his solicitor on an earlier occasion not to answer them; he did not think it appropriate that he should answer the same questions in the context of Mr McClelland’s enquiries. We are aware from the information provided to us that Mr Warren has been subject to criminal investigation by the Respondents, though we do not know the nature of those enquiries, nor their outcome. We are willing to accept that Mr Warren was justifiably cautious about replying to Mr McClelland’s questions, although it is difficult to understand why he should have refused to answer some of those recorded in Mr McClelland’s note, or why a solicitor should have advised him not to do so; and we observe that Mr Warren’s reluctance to answer the questions had disappeared by the time he gave evidence to us.
11.	After the meeting Mr McClelland made a further note, summarising his conclusions, which he divided into three categories — “indications that the business is a sham”, “indications that a genuine business exists” and “other factors”. The first category contains by far the greatest number of entries, and that fact led Mr McClelland to his decision that he had been right to cancel Innova’s registration, and to conclude that it should not be reinstated. He communicated those decisions to Innova in a brief letter of 20 February 2004. He did not then give any reasons but, at the request of Innova’s advisers, gave some particulars of his reasons in a further letter of 8 March. The letter does not reproduce Mr McClelland’s note, but it does set out the gist of it. The essence of Mr McClelland’s view was that Innova was not carrying on a genuine business, and that it should correspondingly not be registered for VAT.
12.	The nature of the business in which Innova claims it was engaged is the “secondary market” as it was described by Moses J in R (Teleos plc and others) v Customs and Excise Commissioners [2004] EWHC 1035 at [80] to [83]: 
 “[80]. In order to place the decision of the Commissioners to assess the claimants in context it is necessary to outline a description of the trade in mobile telephones. The global market for mobile telephone handsets in 2003 is said to be approximately 500 million pieces a year. This number is increasing. Products are designed to operate in any country. The trade in mobile phones has become similar to that in other commodities such as oil, coffee beans and pork bellies. There is a primary market in which mobile phones are supplied directly by manufacturers to distributors, which service for example retail chains. 
[81]. There is also a secondary market described by Mr Hewetson, director of Rapid Marketing Services Ltd, in his second statement as a “grey wholesale market”. It is on that market that the claimants trade. In the primary market there may be delivery delays for up to six months for new models. This results in much speculative ordering, by retailers, distributors and networks. Retailers, distributors and networks may be left with either too few or too many mobile phones of a particular model. The grey market has developed in order to deal with over or under supply and to redistribute products wherever there is an actual retail demand. Manufacturers might also produce, as a matter of speculation, excess stock which, if another model is launched which is more attractive to consumers, will leave that manufacturer with an excess of telephones. The grey market is used also to clear older products. Those retailers or distributors who have ordered too many telephones may sell those, which are excess to their requirements, onto the grey market for immediate cash. If retailers or distributors have under-ordered, because of the delay in production it will be necessary for them to buy from the grey market. 
Supply and retail demand and accordingly price, fluctuate daily. A trader may buy a batch of telephones one day, for cash, and discover that the price of telephones has fallen by as much as 20% the next day. 
[82]. The market dictates that transactions have to be completed on the same day. Purchases are usually for cash on delivery and it is uneconomic to purchase for volumes of less than 1000 units. If a trader holds onto a product for more than 24 hours it risks losing substantially. Profit margins are low, in the region of 2 to 4 percent. Success is based on turnover. Traders only hold stock for very short periods and, usually, turn over their working capital between four to six times a week. Thus it is important that transactions are completed within the course of one working day. 
[83]. Some warehouses are sufficiently secure for goods of small size and value. Stock is often bought and sold by telephone a number of times a day without moving from the secure warehouse. Such secured warehouses are shared by many companies which pay in proportion to their use of that warehouse.”
13.	Mr McClelland told us that he accepted that as a fair description of the grey market in mobile telephones, of which he had some experience. But, he said, he did not consider Innova was truly engaged in the market. It was, he thought, no more than a façade because it was insolvent, had no overdraft or similar facility with its bankers, carried no insurance, incurred no sales or marketing costs, did not carry out any checks on its suppliers or customers beyond making telephone calls to the Commissioners’ office at Redhill which dealt with enquiries about traders’ extant VAT registrations, never took delivery of goods or made any inspections of what it had bought, had no pre-printed stationery and had no auditor, and Mr Warren appeared to have limited knowledge of the goods he was dealing in, did not meet the company’s suppliers and customers and was unable or unwilling to explain how he made contact with new suppliers and customers.
14.	Mrs Preston mounted her attack on those various reasons: Mr McClelland was mistaken and his conclusion, she maintained, could not be supported. We accept that there is merit in some of her challenges. Mr McClelland’s conclusion that Innova was insolvent was based almost entirely on the fact that it owed about £33,000, as he thought, to the Commissioners. It emerged that the debt was rather less and we agree with Mrs Preston that the mere existence of an unsatisfied debt does not necessarily lead to the conclusion that the debtor is insolvent. We agree with her, too, that a trader would not need any overdraft facility if it had adequate working capital, although Mr McClelland told us it was merely a factor he took into account, and we observe that there was no evidence available to us of the level of working capital which Innova had. The fact that it was making and requesting “third party payments” (to which we shall come shortly) suggests that it had little. The lack of insurance, too, is perhaps not an important factor. While we think he was misguided (the more so if the business was indeed genuine) we accept that Mr Warren believed it was unnecessary. We are not persuaded that Innova’s incurring little or no sales or marketing costs is significant. The nature of the business it claimed to be engaged in would not, we think, require much more than a good set of contacts.
15.	We are persuaded, however, that there is substance in the other factors identified by Mr McClelland. We would expect any dealer in a commodity to have some knowledge about it, not necessarily in a technical sense, but in relation to its value and whether demand for it was increasing or diminishing. Mr Warren’s knowledge appeared to be slight; as long as he could sell a consignment for more than he was required to pay he was satisfied. Mrs Preston argued that no more was required. We disagree; in our view a prudent businessman would want to be sure that he was paying the lowest reasonable price and selling for the highest price he could reasonably obtain. The documentation relating to Innova’s sales and purchases which Mr Warren produced, however, showed that on every occasion, regardless of the model of telephone or the quantity of telephones in the consignment, Innova achieved a profit of 50p per unit. We do not find that fact consistent with genuine trading, which would, in our view, show differences in profit from one deal to another. We observe also that Innova appears, unwittingly, to have dealt in telephones designed to be used in Arabic-speaking countries. This disclosure evidently surprised Mr Warren, who could not explain why Innova should have bought such goods nor why it should fail — as it evidently did — to inform its customer of the unusual specification.
16.	It is, perhaps, of relatively little importance that Mr Warren did not meet his suppliers or customers since the same documentation shows that all of the telephones in which Innova dealt, at least in the period to which the documentation relates, were bought from one supplier, and sold to only two customers. We do not, however, find that a factor consistent with the operation of a genuine grey market such as Moses J described, in which one would expect a trader to deal with a multiplicity of suppliers and customers.
17.	The documentation produced by the Appellant included sheets described as a “Supplier Declaration” on which, among other things, traders were requested to certify that the goods in question had been inspected by the supplier or its agent. Mr Warren conceded that he had never inspected the goods himself; instead he relied, sometimes, on a telephone call to the warehouse at which the goods were held. That was not, as he acknowledged, something he had mentioned before he gave his evidence, and we do not believe that Mr Warren made such a call, even occasionally. Rather, we think, he relied on the certificates he received from his supplier when giving a corresponding certificate to his customer and upon his belief, as he put it in his evidence, that people would not pay for non-existent goods. The fact that Mr Warren was willing to part with Innova’s money without first satisfying himself that the goods Innova was buying actually existed (or that they corresponded with what he had agreed to buy) belies that assertion. Likewise we find it surprising that Mr Warren — as he conceded — made no checks on the financial standing of the other companies with which he was dealing. He said that, in ordinary circumstances, the system by which goods were never released until payment was made protected Innova’s interests but it does not appear to have occurred to him that Innova might buy goods for onward sale, only to find that the intended purchaser did not have the means to pay for them, and that Innova might be left with goods for which it had no buyer. The system of third party payments, too, seems to us to have left Innova exposed.
18.	In Teleos plc Moses J mentioned the possibility that goods might pass through the ownership of several dealers in rapid succession, without actually moving from the warehouse in which they were stored. Nevertheless, his description of the market carries with it the implication that, at some point in the chain there is a trader with too many telephones and, at another, a trader with too few, and that in a genuine market goods will eventually find their way from the former to the latter. It was clear to us from the evidence we had that it was never in Innova’s contemplation that it would make any effort to move the goods, either by taking them from its supplier and putting them into safe storage, or in delivering them to its customer. We draw the inference from Mr Warren’s evidence that those were typical of all of Innova’s deals, and that Mr Warren would have had no idea how to arrange secure transport had it been necessary. That is not necessarily an indication that Innova was not truly in business, but it was certainly not in the business of satisfying a physical need.
19.	Mr McClelland was clearly influenced by the fact that Innova had not appointed an auditor. Mr Warren pointed out that, by the time of Mr McClelland’s enquiries, the company had not been required to prepare trading accounts, and there was consequently no need for an auditor. That may be true, but it is nevertheless a matter for some surprise that Mr Warren had not sought some assistance from accountants. On his own evidence, Innova’s turnover was well over £1 million, profit was considerable and he was having difficulty preparing and filing its VAT returns. It is by no means a conclusive factor, but we share Mr McClelland’s view that the appointment of an auditor would be an indicator of a genuine business. We view Mr Warren’s failure to obtain printed stationery, and his carelessness about Innova’s correct title, in much the same way.
20.	It is the system of “third party payments” which, in our view, is the most telling factor. The evidence indicated that Innova’s supplier asked that the purchase price of the goods be paid to traders other than itself, save for a modest sum which could be deduced to be the supplier’s profit. In some cases three payments were required, suggesting that Innova was paying the amount of its profit to its immediate supplier, making a similar payment to the supplier next before in the chain, and a substantial payment to that supplier’s supplier; in other words, it was making payments to the three dealers which preceded itself in the claim. At first, as we understood the matter, Innova did not make a similar request of its own purchasers, but latterly it had begun to do so. It is, of course, not uncommon for a trader to ask its customers to make payment to a third party, for example if it factors its debts — but that is not the case here. Mr Warren suggested that Innova was earning commissions, but we do not accept that explanation. Innova’s case has always been that it was trading as principal, and the documentation produced to us is consistent only with its doing so. By asking for payment to be made to a third party a trader necessarily reveals the identity of its own supplier. It is, of course, possible that dealers in the mobile telephone market are scrupulous and would not contemplate going direct to a supplier whose identity had been so revealed, but it was not our impression from Mr Warren’s evidence that traders with scruples were commonplace in this market.
21.	The Appellant’s case is that it was trading not only in mobile telephones but also in optical goods. It will be remembered that Mr Warren told us Innova had bought stock from the liquidator of his previous company and it had, he said, tried to develop the business of selling optical goods ever since. He had offered to show Mr McClelland the stock he kept in the cellar of the Birmingham premises on the occasion of the meeting in February 2004, an offer which Mr McClelland had declined; and he had been organising a sales event which took place on 22 February 2004. He produced a copy of a mail shot he said he had sent to local opticians, inviting them to the event at a hotel. He told us the event had been rather unsuccessful. There was no other documentary evidence before us about the event — for example the hotel’s invoice — nor about Innova’s trade in optical goods.
22.	We are willing to accept that Innova may have bought stock from the liquidator. We do not, however, believe that it has since made any serious attempt to engage in the business of optical sales. In particular, we do not believe that the sales event we have described took place. We are satisfied, from the vague, even evasive, manner in which Mr Warren gave his evidence about it, and his failure to produce at the hearing any corroborative evidence when he must have known of its significance, that it is a pretence designed to give the impression that Innova is engaged in business and entitled to VAT registration.
23.	It was common ground that our task is supervisory, that is, we must ask ourselves whether we are satisfied that Mr McClelland’s decision was one taken after considering the relevant, disregarding the irrelevant, and applying the law correctly, and is one which could reasonably be reached: see Brooks v Customs and Excise Commissioners (1994, decision 11752). We have no doubt that his decision satisfies those requirements. There is, we have concluded, ample evidence to support his view that Innova was not engaged in any genuine business venture, such as that described by Moses J in Teleos plc, or of trading in optical goods. On the contrary, we think Mr McClelland was right to conclude that the “business” was a sham, designed to create a paper trail. We cannot accept that any legitimate businessman would buy and sell goods which, though supposedly satisfying a demand in the retail market, never moved from a warehouse, and whose existence he never verified, and that he would happily disclose to his customers the identity of his own suppliers, with the risk that he would be by-passed. We are satisfied that Mr Warren did attempt to conceal from Customs that Innova had changed its address, and that he did so with a view to avoiding an examination by Customs of the company’s records, since he knew that they would reveal its “business” for what it was. The Commissioners’ cancellation of Innova’s registration and their refusal to reinstate it cannot be faulted.
24.	For those reasons we dismissed the appeal. We were not asked to make any direction in respect of costs.

COLIN BISHOPP
CHAIRMAN
RELEASE DATE: 22 March 2005
MAN/04/1620