150 firms take on the taxman over 'carousel fraud

The high court yesterday took the first step in allowing a group of up to 150 companies to make damages claims against the government which could run into hundreds of millions of pounds.

The case is related to so-called "carousel fraud" and could last years. The court made a preliminary ruling which, if approved, would allow solicitors DLA Piper to launch a joint action on behalf of potentially 150 companies hoping to claim damages from Her Majesty's Revenue & Customs about withholding VAT repayments to them.

The government has been struggling to stem losses from fraudulent claims for VAT repayments that run into billions. But its attempts to clamp down on the fraud caught up many innocent traders of items such as mobile phones and computer chips who are now seeking recompense for their losses, known as "consequential damages", rather than the VAT itself.

Sir Igor Judge, president of the court's Queen's bench division, is likely to approve the provisional ruling within weeks.

DLA Piper's senior partner Simon Airey said: "This is the opening shot of what may become a very substantial litigation. The grant of a JLO [joint litigation order] will allow a large number of companies to pursue claims for damages.

"However, a cut-off date for joining the litigation is likely to be included in the order so companies who have had VAT withheld and believe that they have suffered loss as a result should take legal advice without delay. But unscrupulous traders should not treat this as a crock of gold at the end of the rainbow."

HMRC had already agreed to the JLO because it felt that would be easier than dealing with many individual claims. An HMRC spokesperson said it had not acted unreasonably and would contest any claims for damages and/or compensation.

"It is part of HMRC's responsibilities in the care and management of tax to undertake legitimate verifications of VAT claims prior to payment. These claims total many millions in an area of significant fraud. We would be failing in our duties to taxpayers in general if we did not take adequate steps to ensure traders were entitled to this money before we repaid it."

Carousel, or "missing trader" fraud, occurs when a firm imports goods such as mobile phones from another country free of VAT, sells them on to another firm and then disappears without paying the VAT to HMRC. A carousel occurs when many traders pass the goods on and then re-export them, reclaiming the VAT.

Over the past few years the HMRC has made various attempts to tackle the issue, including refusing to refund VAT where it suspected fraud. The carousels, however, often contain innocent traders.

In January Europe's highest court ruled that companies were entitled to reclaim VAT wrongly held on to by the authorities. Tax lawyers had said this could open the door to a number of legal claims against the government since some companies were forced to stop trading because of the HMRC's actions.

The European case involved three companies - Optigen, Fulcrum Electronics and Bond House Systems - which were refused VAT refunds totalling almost £40m after HMRC said they were involved in fraudulent transactions.

HMRC had ruled in 2002 that the three companies' sales and purchases did not constitute "economic activity" for the purposes of VAT, but the European court of justice rejected that argument.

Although the companies were found to be blameless they have now ceased trading.

Figures from the National Audit Office showed that £1.25bn in refunds had been withheld from companies where unconnected third parties may have been involved in VAT fraud.

Explainer: How fraudsters pocket millions

Carousel fraud grew up a few years ago when importers and traders of small but highly valued goods such as mobile phones realised they were being relied on to post large VAT cheques to Customs & Excise (as it was then known) whenever they sold goods that had been imported VAT-free to someone who paid them VAT.

They woke up to the fraud of simply disappearing with the VAT, which on a truck load of mobile phones, could run into hundreds of thousands of pounds. Then they moved to sending the goods round a carousel, whereby they change hands several times and then are re-exported, at which point VAT is reclaimed from Revenue and Customs (as it is now known). The goods can go round a carousel many times as VAT is siphoned off, meaning huge losses for the Treasury.

The fraudsters have now become really sophisticated and have widened the categories of goods they trade to avoid detection. The losses from carousel fraud, estimated at £1.5bn in 2004/05, are on the rise again as criminals come up with ever more ingenious ways of helping themselves to the VAT pot. HMRC has mounted a huge operation to combat the fraud but has often struggled to prosecute fraudsters because the crimes are so complex and are difficult to prove.

The problem affects many countries in the European Union, all of which have essentially the same system as in Britain and all of which are suffering losses.