Businesses could seek hundreds of millions of pounds in VAT repayments after the taxman lost a landmark carousel fraud case.

Livewire Telecom successfully appealed against HM Revenue & Customs for refusing to repay £2m in tax withheld on the suspicion that the trader should have known it was trading in a carousel fraud chain.

The case is understood to be the first to test rules on whether companies have ‘knowledge or means of knowledge’ of frauds in carousel fraud chains.

The verdict sets up a high burden of proof for Customs’ officials hoping to withhold VAT.

Carousel fraud has been HMRC’s biggest fraud issue to tackle in recent years, costing the UK billions of pounds a year.

HMRC had withheld VAT from traders involved in fraud chains, until challenged by Bond House. A ruling in that case decided that traders could only be denied the tax if they had knowledge, or means of knowledge, of the frauds.

Dr Avery Jones, chairman in the Livewire tribunal, found that HMRC could not prove that Livewire was aware it was part of a fraudulent chain despite some odd patterns of trading.

‘Looking at the totality of the evidence, we have identified a small number of odd features but neither separately nor when taken together do they come anywhere near to indicating knowledge or means of knowledge of the fraud (i.e. the fraud by the missing traders) by the appellant,’ said Dr Jones.

He said HMRC could not rely on the trader knowing that carousel fraud exists and that customs needed to provide ‘cogent’ evidence of knowledge or means of knowledge. A company only has to take ‘reasonable’ precautions and shouldn’t have to police carousel fraud themselves.

Vantis, which conducted the appeal on behalf of Livewire, said the ruling was ‘extremely significant’.

‘In winning this case we have been able to overturn HMRC’s most common and damaging misconceptions about trading in the mobile phone grey market and we have also succeeded in setting a number of important legal and factual benchmarks, which will impact upon future cases of this type,’ said Vantis Tax managing director Don Mavin.

Paddy Behan, head of indirect tax services at Mercury Tax Group, said the decision was a ‘major setback’ for HMRC: ‘HMRC hasn’t struck the balance between protecting revenues and the rights of innocent businesses.’

HMRC said it is considering whether or not to appeal.