[2009] UKFTT 363 (TC)

									TC00301

Appeal number LON/2006/875

Community Law – Fiscal neutrality – Exemption – Exclusion of provision of “gaming machines” from exemption – Whether taxed machines similar to exempt machines – Relevance of regulatory regime – TNT [2009] STC 1438 considered – Whether FOBTs exempt comparators – Whether on facts due diligence defence established to breach of fiscal neutrality
Exemption- Slot machines – Exclusion of “gaming machines” from exemption – VATA 1994 Sch 9 Group 4 – 6th Directive Art 13B(f) – Breach of fiscal neutrality – Period of breach – Appeal allowed for all periods

FIRST-TIER TRIBUNAL
TAX CHAMBER

	THE RANK GROUP PLC	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS (VAT)	Respondents

				TRIBUNAL: 	JUDGE THEODORE WALLACE 
						A J RING CTA (Fellow)

Sitting in public in London on 5 to 9 and 12 to 15 October 2009

Dr Paul Lasok QC and Valentina Sloane, counsel, instructed by Deloitte LLP, for the Appellant

Christopher Vadja QC, George Peretz and Laura Elizabeth John, counsel, instructed by the Solicitor to the Commissioners for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2009

DECISION

1.	This is stage 2 of the appeal against the decision to refuse a repayment claim in respect of VAT paid from 1 October 2002 to 5 December 2005 on income from slot machines.   This decision concerns the period during which the United Kingdom was in breach of the principle of fiscal neutrality in the taxation of gaming machines and whether the facts for any defence of due diligence in remedying the breach had been established.
2.	The claim was in respect of gaming machines known as Jackpots covered by section 31 of the Gaming Act 1968 and gaming machines known as Amusements with Prizes (“AWP”) covered by section 34 of that Act.  The claim was for repayment of £29,959,104.  The basis of the claim was that the exclusion from exemption of income from gaming machines covered by sections 31 and 34 of the Gaming Act 1968, by reason of Note (1)(d) to Group 4 of Schedule 9 to the VAT Act 1994 because of the definition of “gaming machine”, when income from similar machines within section 21 of the Gaming Act 1968 and section 16 of the Lotteries and Amusements Act 1976 were exempt, infringed the principle of fiscal neutrality under Community law.  The Appellant also relied on the exemption from VAT of income from Fixed Odds Betting Terminals (“FOBTs”).  Article 13B(f) of the Sixth Directive exempted betting, lotteries and other forms of gambling “subject to conditions and limitations laid down by each Member State.”
3.	In Decision No.20777 reported at [2008] V&DR 304 we decided that from November 2003 at the latest United Kingdom law and practice were prima facie in breach of the principle of fiscal neutrality in that similar products were taxed differently. November 2003 was the date when Star City Casino opened using Cadillac Jack machines covered by section 21 of the Gaming Act 1968.  In that decision we held over for further evidence the question whether the disparity in treatment extended back over the whole period of the claim.
4.	The appeal by the Respondents against that decision was dismissed by Mr Justice Norris in the Chancery Division on 8 June 2009 [2009] STC 2304.  On 11 August 2009 the Court of Appeal gave permission to appeal against the decision of Mr Justice Norris.
5.	We also held over the questions whether there is a defence to a prima facie breach of fiscal neutrality if it is shown that the United Kingdom acted with due diligence in responding to the development of exempt machines by amending the law to end the disparity in treatment and whether on the facts the United Kingdom had acted with due diligence.  These questions which had not been determined by the Tribunal were not covered by the appeal to the Chancery Division.
6.	The question as to whether the disparity in treatment extended over the whole period of the claim involves deciding when exempt comparator machines came onto the market. This is not confined to machines operated by the Appellant. Apart from machines covered by section 21 of the Gaming Act 1968 and section 16 of the Lotteries and Amusements Act 1976, which we refer to as “section 16/21 machines”, it involves consideration of whether FOBTs were similar to taxed machines within sections 31 and 34 of the Gaming Act 1968 and were thus relevant comparators.  In relation to the period of disparity of treatment, FOBTs are not strictly relevant if section 16/21 machines were on the market at the start of the period of the claim.  However, since FOBTs were on the market from 1998, if FOBTs were relevant comparators, then the disparity preceded the period of the claim regardless of the section 16/21 machines.
7.	If the FOBTs were relevant comparators, Mr Vadja accepted that the defence of due diligence did not arise on the facts.
8.	We were asked by the parties to give a decision on the due diligence issue whether or not we concluded that FOBTs were relevant comparators, since a higher Court may come to a contrary conclusion.
9.	A further complication arises as to the relevance of evidence of competition to the question whether and when there were relevant comparators on the market.  In our earlier decision we concluded that, since the section 16/21 machines met the same needs of consumers as taxed machines, the disparity in treatment did result in a breach of fiscal neutrality without the need to identify distortion of competition or imbalance in the market.  Accordingly we made no findings as to competition or imbalance in the market as an additional requirement to similarity.  Mr Justice Norris endorsed the approach of the Tribunal at paragraph 36 of his judgment.
10.	The third ground of the Respondents’ appeal to the Court of Appeal is as follows:
3.	The learned judge further erred in law in upholding the conclusion of the Tribunal that, in relation to any difference in VAT treatment as between (i) Comparator Machines and (ii) Taxable Machines, there was thereby an infringement by the United Kingdom of the principle of fiscal neutrality.  Since the evidence was that the difference in VAT treatment of Comparator Machines and Taxable machines did not cause any distortion of competition, the learned Judge should have set aside the Tribunal’s decision and dismissed the Respondents’ appeal against the Appellants’ decision to reject its claim for repayment of VAT.”
On the third day of the hearing the Tribunal raised the question whether in view of this ground of appeal the present decision should address the facts as to whether there was an actual distortion of competition.  Both Dr Lasok and Mr Vadja agreed that the Tribunal should not engage in such a factual investigation since it is unnecessary on the basis of the decision of Mr Justice Norris by which the Tribunal is bound.  We observe that any finding as to whether there was actual distortion of competition on the facts and its extent would have involved the prior question as to what legal test should be applied.

The evidence
11.	In addition to the evidence at the first hearing, the following witnesses confirmed statements and were cross-examined: David Lees, Head of Machines Business at Ladbrokes; James David Thomas, until 2006 the chief executive of Thomas Holdings Ltd, the parent company of Thomas Estates Ltd; Simon Thomas, managing director of Thomas Estates Ltd until 2006; John Appleton, director of Electronic Leisure at Mitchells and Butlers Plc; Anthony Boulton, managing director of Project Coin Machines Ltd; Tom Kavanagh, formerly secretary to the Gaming Board of Great Britain and from 1 October 2005 deputy chief executive of the Gambling Commission, and Philip Sears and Brian O’Kane, respectively head of policy for VAT exemptions and zero and reduced rates and head of policy for excise duties at Customs and Excise (now HMRC) at the relevant time.  A statement by Bernard Cunningham, Head of Leisure at the Department of Culture, Media and Sport, was admitted without cross-examination.  Apart from exhibits to the witness statements, the documentary evidence included material disclosed by the parties and by the Gambling Commission and the Department of Culture, Media and Sport.  Both parties provided written submissions and also submissions on the evidence which we have considered with care.  There was a full transcript of the hearing.
The effect of TNT
12.	While accepting that the Tribunal must follow Mr Justice Norris on the relevance of evidence of distortion of competition, Mr Vadja submitted that the Tribunal must apply the later decision of the Court of Justice in R (TNT Post UK Ltd) v Revenue and Customs Commissioners (Case C-357/07) [2009] STC 1438 when deciding whether there has been a breach of the principle of fiscal neutrality in a regulated industry; he said that in such cases, of which the present is an example, the Court focuses on whether there is different regulation and the perception of the user is not relevant.  He submitted that on this aspect the decision of Mr Justice Norris has been overtaken by the decision in TNT.  He said that all the relevant activities and supplies involving FOBTs, section 16/21 machines and Part III machines were under different regulatory regimes, so that the position was as in TNT and the activities were therefore not similar for the purposes of fiscal neutrality.
13.	Since the effect of the TNT decision is relevant to the identification of comparators, a matter which is fundamental to this decision, we consider at the outset whether it does overtake the decision of Mr Justice Norris upholding the Tribunal.
14.	TNT Post UK Ltd (“TNT Post”), whose services were subject to VAT, brought judicial review proceedings against HMRC challenging the lawfulness of the exemption under Group 3 of Schedule 9 to the VAT Act 1994 enjoyed by Royal Mail, which was the sole universal postal service provider in the United Kingdom pursuant to a licence under the Postal Services Act 2000.  The licence obliged Royal Mail to provide at least one delivery to every address in the country on every working day and one collection every day from every access point at affordable prices uniformly applied throughout the United Kingdom.  
15.	TNT Post was licensed to convey letters within the United Kingdom but without the universal service obligations imposed on Royal Mail.
16.	TNT Post, together with the Swedish and Finnish governments, contended that in a liberalised market exemption of the universal service infringed the principle of neutrality and harmed competition.
17.	At paragraph 59 of her opinion, Advocate General Kokott said,
“59.	The principle of fiscal neutrality, which is inherent in the common system of VAT …, precludes economic operators carrying out the same transactions from being treated differently in relation to the levying of VAT [citing inter alia J P Morgan Fleming Claverhouse Investment Trust plc v Revenue and Customs Commissioners (Case C-363/05) [2008] STC 1180, paragraph 46, a case to which we refer as AITC].  It includes the principle of elimination of distortion of competition as a result of differing treatment for VAT purposes [citing AITC paragraph 47].”
At paragraphs 61, 62 and 63 she said this,
“61.	… It is in fact compatible with the principle of neutrality to exempt only the services performed by the universal service provider, in so far as, by reason of the special legal requirements to which they are subject, those services are not comparable with the services provided by other postal service providers and, therefore, no distortions of competition arise.
62.	The essence of the universal services guaranteed … by Royal Mail is that all users are offered a certain range of postal services at all points … at a fixed tariff …
63.	TNT is not obliged to offer comparable services.  The principle of fiscal neutrality therefore categorically does not require that TNT’s and Royal Mail’s transactions be treated equally for tax purposes … [T]he assessment of the comparability of the transactions hinges not only on the comparison of individual services, but on the fact that they are part of a comprehensive range of provision offered by the public postal network.”
18.	The Court of Justice endorsed the approach of the Advocate General, saying this at [38] and [39],
“[38]	As the Advocate General observes in point 63 of her opinion, the assessment of the comparability of the services supplied hinges not only on the comparison of individual services, but on the context in which those services are supplied.
[39]	… [O]n account of the obligations … required under its licence and connected with its status as the universal service provider, an operator such as Royal Mail supplies postal services under a legal regime which is substantially different to that under which an operator such as TNT Post provides such services.”
g19.	Mr Vadja made the following submissions based on TNT.  
(1)	In looking at comparability for the purposes of fiscal neutrality in a regulated industry, it is necessary to look not at a comparison of the individual services but at the regulatory context in which the services are supplied.
(2)	It is necessary to look at the services as a whole rather than the individual services.
(3)	Royal Mail’s services were provided under a substantially different legal regime to that applying to TNT Post.
(4)	The ECJ reached this conclusion although some services were identical and in competition.
(5)	The conclusion of the ECJ did not depend in any way on whether the services were considered to be similar or identical from the perspective of the user.
(6)	The ECJ would have reached the same result if TNT had not had a licence and was acting unlawfully.
20.	Mr Vadja said that, following TNT, when dealing with regulated industries the perception of the users, here the players, is not a relevant factor when considering fiscal neutrality.  The Court focuses on whether there is different regulation.  He said that there are significant differences between the regulatory regimes governing FOBTs and Part III of the Gaming Act 1968 and between the regimes in Parts II and III of that Act.  He said that the test whether a regulatory regime is “substantially different” is easily ascertainable and objective and does not depend on looking into the minds of individual consumers.  It is consistent with the principle of legal certainty referred to by Lord Walker in Lex Services plc v Customs and Excise Commissioners [2004] STC 73 at [29].
21.	Dr Lasok submitted that TNT did not change the law at all.  The submission that when dealing with a regulated market, you look only at the type of regulation, and if the regulatory regime differs as between two classes of supplies the two classes are not similar was wrong.  He cited paragraph 61 of the Advocate General, emphasising the words “in so far as”.  He said that the significance of the regulatory regime in TNT was that the difference in legal regime affected the nature and comparability of the services in question; in this it was unlike AITC which was also a case with significantly different regulatory regimes.  In TNT the regulatory regime created a material and objectively ascertainable difference in the nature of the services in question which override everything else.  In the present case the Tribunal must ask the question whether or not the regulatory regimes had any or any overriding relevance to the similarity of the supplies.  
22.	In our judgment the decision of the ECJ in TNT does not have the effect that supplies under different regulatory regimes are as a matter of principle not similar for fiscal neutrality purposes.  We did not understand Mr Vadja to submit that it did have such effect, since he posed the question whether the regulatory regimes were substantially different.  Clearly the greater the difference in regimes the greater is the relevance of such difference.  In TNT the obligations on Royal Mail under its licence overrode everything else.  In AITC there were regulatory differences in that investment trusts unlike unit trusts were not subject to authorisation by the Financial Services Authority, however the Court of Justice did not refer to this as a material factor in its decision.  In Finanzamt Gladbeck v Linneweber (Case C-453/02 and C-462/02) [2005] ECR I-1131; [2008] STC 1069 the Court of Justice held that the principle of fiscal neutrality precluded different treatment of games of chance and gaming machines operated by licensed public casinos compared with those operated by other traders.  Licensing of public casinos clearly involved a regulatory regime.
23.	In our judgment, in contrast to the position in TNT, the differences in regulatory regimes between FOBTs and Part III machines and between section 16/21 machines and Part III machines fell far short of overriding everything else.  The differences are merely a factor in deciding whether or not the supplies had “similar characteristics and [met] the same needs from the point of view of consumers”, see per Mr Justice Norris in the Chancery Division at [21].  The comparison is to be made “at a high level of abstraction and on the basis of broadly defined categories.” The consumers are of course the players.
24.	As between section 21 machines, which were covered by Part II, and section 31 machines, falling within Part III, Mr Vadja stated at the first hearing that HMRC were not arguing that there was an objective consumer difference between a section 21 machine and a section 31 machine and for that reason was not cross-examining the Rank witnesses who stated that from the consumer’s point of view the two were the same.  In closing in the first hearing on 23 April 2008 he stated [Day 8, page 52-3],
“We accept that section 31 and 34 machines on the one hand and section 16 and 21 machines on the other hand are intrinsically similar … .  The consumer is not going to be able to tell the difference between one and the other.”
In that hearing he contended that the fact that they were intrinsically similar did not mean that they were in competition.  The Tribunal’s rejection of that argument was upheld by Mr Justice Norris, but is subject to the further appeal to the Court of Appeal. In the present hearing Mr Vadja’s contention was that the differences between Part II and Part III machines were overriding.  We have already rejected that contention which only appeared clearly in his closing address.  We did not understand Mr Vadja as having resiled from his acceptance at the first hearing that from the consumer’s viewpoint the machines were intrinsically similar. In respect of section 16/21 machines his submissions were directed to a comparison with FOBTs rather than Part III machines, see Part II of the skeleton argument of 28 September 2009.  
25.	In view of our conclusions as to the effect of TNT (see paragraphs 21 and 22), we proceed on the basis that the section 16/21 machines were similar to the Part III machines for the purposes of fiscal neutrality and that there is no need to consider the regulatory regime under Part II.

Comparability of FOBTs and Part III gaming machines
26.	Mr Vadja made no such concession as regards the comparability of FOBTs with Part III machines.  However, in view of our conclusion that the differences in regulatory treatment fell far short of overriding everything else, as was the case in TNT, those differences were only relevant in so far as they impacted on the needs of consumers at a high level of abstraction.
27.	In Linneweber the Court of Justice decided that the exemption cannot depend on the identity of the operator, in that case a licensed casino operator, or on where the activity is carried out, there a licensed public casino; the legal form by means of which the activity was carried out was held as a rule to be irrelevant, see at paragraph [25].  The question was whether the activity was comparable.
28.	Comparability cannot therefore depend on whether the operator was licensed, whether as a bookmaker or under the Gaming Act 1968 or the Lotteries and Amusements Act 1976 or at all, or on whether the activity was carried out in a licensed betting office, an amusement arcade, a public house, a bingo hall or elsewhere.  In any event the majority of consumers would be unaware of the licensing requirements for the various premises. 
29.	The second question referred to the Court of Justice in Linneweber was as follows:
“2.	Does Article 13B(f) of [The Sixth Directive] prohibit a Member State from making the operation of a gaming machine subject to value added tax if the operation of a gaming machine by a licensed public casino is exempt, or must the game of chance machines operated outside casinos also be comparable for that purpose in essential respects, for example as regards the maximum stake and the maximum winnings, with the gaming machines in the casinos?”  (The italics are ours.)
The first question in Akritides, the linked case, included a reference to the game rules.  The Advocate General said at paragraphs 58 and 59 that in assessing comparability the potential scale of winning and the gambling risk are factors which must be taken into account.
30.	Having decided that the Directive precluded legislation making gaming exempt in licensed public casinos “while the operation of the same activity by traders other than those running casinos does not enjoy that exemption”, the Court decided at [31] that in the light of the answer above there was no need to answer the further question.
31.	In our judgment the Court of Justice would have answered the further question referred if it had considered the maximum stake, the maximum  winnings and the game rules to be relevant factors in assessing whether the casino operators and others were operating “the same activity”; however it stated at [31] that there was no need to do so.  If the Court had agreed with paragraphs 58 and 59 of the opinion of the Advocate General it would have said so, since this would have been an essential qualification to its answer to the questions referred.  It is to be noted that at [26] the Court did specifically endorse paragraph 38 of the Advocate General’s opinion where she said in relation to Fischer v Finanzamt Donaueschingen  (Case C-283/95) [1998] STC 708,
“The Court could not have given this ruling if it were indeed true that the games of chance offered by public casinos already differed significantly from those offered by commercial operators because of the difference in accessibility, the gambling environment, the ‘gambling culture’ or the different circle of user.”
32.	Mr Vadja relied on a series of differences between FOBTs and Part III machines which in our judgment are therefore not relevant on the basis of the decision in Linneweber.  In particular he relied on the different stake and prizes limits and the fact that complex betting patterns were available on FOBTs which the rules prevented on Part III machines.  Mr Justice Norris decided that the comparison is to be made from the point of view of the consumers at a high level of abstraction (see paragraph 23 above).
33.	We are satisfied that all the witnesses gave evidence to the best of their knowledge and belief.  Their knowledge of the primary facts varied.  A considerable amount of the evidence was opinion, particularly as to the perception of players.  Since the witnesses for the Appellant had been concerned with marketing the machines or rather their use, they had clearly more reason to consider the perception of players than those witnesses who had been concerned with regulation.  It is also important to remember that players inevitably have a wide variety of perceptions and motives. Thus the casual user of a machine at a motorway café is very different from the regular customer of a betting office, a public house or a bingo hall.  The Tribunal has to consider an objective synthesis of the generality of players.
34.	On the evidence we do not regard the fact that compensators were incompatible with fixed odds whereas they could be used with Part III machines to have been a significant factor for the generality of players nor the fact that the winning odds paid on FOBTs bore a direct relationship to the mathematical probabilities of winning.  Again the evidence did not in our judgment support the argument that the higher payout ratio on FOBTs was important to the generality of players.  We accept that these factors were relevant to some players, however most players would be unaware of compensators and the evidence was that some who were aware of stated payout ratios did not believe what they were told.  In any event the reasons for using FOBTs and gaming machines were subjective, in particular, some players did so as entertainment for as long as their money lasted and presumably expected to lose, while others hoped to beat the machine.
35.	Mr Vadja relied on the fact that the low stake limits on Part III machines prevented players covering the table with a large number of bets as could be done with FOBTs.  However, as we have already pointed out, in Linneweber the Court of Justice did not regard the stake limit as sufficiently relevant to require an answer.  In any event there was no evidence to satisfy us that the generality of players did wish to cover the table with a multiplicity of bets.
36.	Another submission was that no player interaction was possible on FOBTs and that no “nudges” were possible.  A further submission was that no blackjack, poker or reel-based games were possible on FOBTs. We do not however regard those differences as sufficient to prevent the generality of players considering the machines as similar at a high level of abstraction.
37.	Mr Vadja also relied on the different social environment between licensed betting offices, with a male atmosphere, no alcohol and limited opening hours, compared with the very different atmosphere in public houses, amusement arcades and bingo halls.  However those differences are inherent in the place where the activity is carried out which again was excluded as a factor in Linneweber. It is necessary for the Tribunal to focus on the activity itself albeit from the viewpoint of the generality of players.
38.	Mr Vadja relied strongly on the fact that FOBTs were regarded as betting rather than gaming.  This was the subject of an action in the High Court in 2003 by the Gaming Board of Great Britain against the Association of British Bookmakers Ltd (“ABB”) in which the Gaming Board sought a declaration effectively stating that FOBTs did not involve betting.  The proceedings were stayed under a Tomlin order under which the ABB agreed to comply with a code of practice. FOBTs continued to be treated as betting. We have considerable reservations as to whether the ABB would have succeeded in resisting the declaration if the matter had gone to trial.  However we do not regard this as relevant since an arcane distinction between betting machines and gaming machines would in our judgment be wholly beyond the generality of users of the machines.  On the evidence before us to the generality of players they were all just gambling machines.
Entry of comparators to the market
39.	We turn now to the question of when comparators came onto the market.  This is relevant, first, as to whether there were exempt comparators for the whole period covered by the claim from 1 October 2002 and, secondly, in relation to the due diligence defence.
40.	Green Shield Stamp machines were developed by Thomas Automatics providing Green Shield stamps as prizes; the first machines were gaming machines and thus covered by section 34 of the Gaming Act 1968 and were therefore taxable.  The Lady Saver machine was launched at the Amusement Trade Exhibition in January 1976.  On the advice of leading counsel a variant was developed allowing for an accumulation of prizes and with an RNG outside the machine so as to come under section 16 of the Lotteries and Amusement Act 1976 rather than Part III of the Gaming Act; those machines were therefore exempt from VAT.  It is not clear whether the launch of Green Shield machines in January 1976 was of section 34 or section 16 machines.  However there were regular exhibitions at which section 16 machines were shown.  Initially Green Shield stamps could be exchanged at Tesco stores, however Tesco ceased to accept those stamps in 1977.  An instant redemption scheme was introduced by Thomas Automatics so that players could take home prizes from displays at arcades.  By 1980 arrangements were made for Woolworths stamps to be exchangeable for gifts at 1,000 stores. Woolworths stamp machines were still in use in 1986.  At one time 5,000 machines were in use before stamps lost their popularity.  There were some multi-terminal section 16 stamp machines using a common RNG.  The evidence of Mr Thomas Senior that section 34 machines and section 16 stamp machines were interchangeable for players who moved from one to the other was not challenged.  It was not suggested that the fact that the prizes were stamps rather than cash was a material factor.  It appears that stamp machines ceased to be used before 1990.
41.	In January 1984 Thomas Automatics were advertising a new version of Express Racing on which players bet on one of ten horses, the result of the race having been pre-recorded.  There was a centre-piece console and up to 10-15 terminals.  This was a section 16 machine.  Due to the restrictions on prizes Mr Thomas senior said that it never really took off.
42.	Bingo Royale was introduced to Thomas Automatics’ Showboat amusement centre in early 2002 with an official launch on 1 March 2002.  It had ten independent slave terminals around a large automatic roulette wheel.  Thomas Estates held 10 Bingo Royale excise licences from April 2002 to March 2003.
43.	A section 16 version of Jackpot Bingo was in use from early 2002; a section 21 version was introduced a year later.  From March 2003 Thomas Estates held 47 section 16 licences for Jackpot Bingo machines manufactured by CMS Gaming Ltd.  The number of machines grew steadily up to 111 in February 2004 where it remained until February 2006.  These had an electronic master top box with RNG into which a number of slave terminals were plugged.  They were in operation in Thomas Estates’ Showboat amusement centre in late 2002 and were exhibited in January 2003.
44.	Project Coin Ltd introduced section 16 versions of Casino King machines in 2003; the first installations in arcades and bingo clubs were in November 2003.  An earlier FOBT prototype was exhibited in January 2003.  Up to 10 terminals worked off one RNG.  Project Coin sold around 500 section 16 machines over two years.
45.	The opening of Star City Casino in November 2003 with Cadillac Jack machines made by Bally Gaming Systems is covered in paragraph 15 of our first decision.  The Gaming Board approved those machines under section 21 on 17 November 2003.  Thomas Estates operated these at Cricklewood from late 2003.
46.	Jackpot Roulette was officially launched by Thomas Estates at the Amusements Trade Exhibition in January 2004.  Thomas Estates received approval under section 21 from the Gaming Board on 30 March 2004.  65 machines were licensed by Thomas Estates in April 2004; by March 2005 the number had risen to 143.  Jackpot Roulette had a number of terminals working off a single RNG.
47.	We find as a fact that all of the models outlined at paragraphs 40 to 46 above were exempt although they were similar to taxed Part III machines for the purposes of fiscal neutrality.  
48.	FOBTs were introduced into UK betting shops in 1998 by Global Draw and were trialled by Ladbrokes in 1999.  The RNG was located off the bookmakers premises and outside the bookmaker’s control.  The first FOBTs involved virtual horse or greyhound racing, numbers games and other fixed odds games.  The rollout of 1,000 machines bought by Ladbrokes was completed by February 2002.  FOBTs became much more profitable when a gross profits tax of 15% on betting profits replaced the 6.75% turnover tax in October 2001.  Following this change in taxation, roulette games were developed with an arithmetical profit margin of 2.7% (1 in 37); this involved a payout over a period of time of 97.3% compared with a profit margin normally set on other FOBTs in the low 80s.  Because the FOBTs involved fixed odds, no compensator could be used to even out the cycles.
49.	Exempt comparators whether section 16/21 machines or FOBTs were in commercial use for the entire period covered by the claim.  We find as a fact that from the viewpoint of the generality of players FOBTs and Part III gaming machines had similar characteristics and met the same needs.  They were similar for the purposes of fiscal neutrality.
50.	We accept the opinion evidence of Mr. Lees that from the players’ perspective there would be very few differences between a FOBT and a gaming machine and that the customer was primarily interested in the opportunity to gamble.  
Due diligence
51.	We remain of the view expressed at paragraph 92 of our earlier decision that there is in law no defence of due diligence to an infringement of fiscal neutrality.  We hold that this is the case even in circumstances where the unequal treatment arises from technological developments. The speed and extent of technological developments appears to be growing; the same may be said of scientific developments generally.  We observe that a defence of this nature would introduce the very element of uncertainty which Mr Vadja submitted should be avoided.  It would potentially extend over a wide variety of activities, not confined to betting and gaming.  In the present case it would involve a difficult judgment as to the time over which it extended, since it could only succeed in full if the Respondents could show that it applied to the whole period.  Furthermore it would sit very uneasily with the right of traders to rely on the direct effect of the Sixth Directive.
52.	At the request of the parties we do however make findings as to when the United Kingdom knew or ought to have known of the presence of the exempt comparators on the market and of the consequent unequal treatment of similar taxed activities.
53.	The obligation to comply with the Sixth Directive is an obligation on the Member State not on particular emanations of the state.  Laws are enacted by Parliament normally on the initiative of Ministers.  Ministers are advised by HMRC, or at the relevant time by the Commissioners of Customs and Excise, and more specifically by the officers to whom the Commissioners delegate the responsibility for Policy.  Mr Vadja submitted that the relevant knowledge of the United Kingdom was that of the tax authority but accepted that he could not cite any authorities in support of that proposition.  He submitted that the fact that the United Kingdom was responsible for all organs of the state in complying with Community Law, did not mean that the relevant knowledge for the purposes of due diligence was the knowledge of the whole Member State.  In our judgment the fact that Ministers relied on Customs for guidance did not have the effect that the relevant knowledge of the United Kingdom was limited to that of Customs, nor was the relevant knowledge of Customs limited to that of the various Policy departments.  In our judgment the knowledge of the Gaming Board and from 1 November 2005 the Gambling Commission, both of which being statutory bodies appointed by Ministers, were relevant knowledge of the United Kingdom.  In any event it was incumbent on Customs and Excise to draw upon the knowledge of the Gaming Board.
54.	We consider next therefore the knowledge of the Gaming Board as to the presence on the market of machines used for gaming which were not gaming machines within section 26 of the Gaming Act 1968.  We are satisfied that the Gaming Board was aware of the use of Green Shield machines under section 16.  The evidence of Mr Thomas senior as to this was unchallenged, including his evidence that it was discussed at a meeting with the Gaming Board attended by leading counsel.  In any event given the widespread use of such machines it would have been extraordinary if the Gaming Board did not know of them.
55.	We accept the evidence of Simon Thomas that the Bingo Royale machines were discussed prior to the launch in March 2002 at meetings with Mr Kavanagh at which no objection was expressed to such machines being operated under section 16: this evidence was not challenged.
56.	There was no challenge to the evidence of Simon Thomas that Jackpot Bingo machines were discussed with the Gaming Board on a number of occasions at an early stage both in respect of the section 16 versions and the later section 21 version.  This was corroborated by the letter by Mr Thomas senior to the Gaming board dated 17 December 2002.  We accept that evidence.
57.	The section 16 roulette game produced by Project Coin as Casino Royale was approved by the Gaming Board in an e-mail dated 17 March 2003 in response to a letter of 7 February following a meeting at which Mr Kavanagh was present.
58.	The Gaming Board endorsed the installation of section 21 machines produced by Crown Gaming in Stanley’s Star City Casino, see the letter of 17 November 2003.  These were known as Cadillac Jack machines.
59.	Jackpot Roulette was approved by the Gaming Board under section 21 in a letter dated 30 March 2004 which followed earlier meetings.
60.	We find as a fact that the Gaming Board knew of all the comparator models with the possible exception of Express Racing.
61.	We now turn to the knowledge of Customs and Excise as to the presence on the market of the exempt section 16/21 machines.  There is no issue as to the knowledge of Customs and Excise of FOBTs; indeed it is conceded by Mr Vadja that no due diligence defence can arise if FOBTs were comparators.  This part of our decision is confined to Customs’ knowledge of section 16/21 machines.  The evidence as to this was far from satisfactory even given the difficulty in collecting information from a wide variety of sources.  It is clear that officers from the excise side of Customs visited the Amusement Trade Exhibitions held annually however there was no evidence from Customs as to what any of them saw or even what was the purpose of their attendance.  There was no evidence from any excise officer or any VAT assurance officer who had visited any of the premises at which any of the machines in question was operated.  The Respondents disclosed notes by one officer of one visit to Star City Casino.  We do not find it credible that there were no other notes and no other visits either by VAT or excise assurance officers.  In his first witness statement Mr O’Kane stated at paragraph 5 that early in 2004 he became aware through reports from assurance officers visiting premises that a new type of slot machine was being found advertised as section 16/21 machines; these were not produced.  We do, however, recognise the difficulty of gathering material from a multiplicity of local offices, particularly when assurance officers may have moved and their notes put into storage.
62.	We accept the evidence of Mr Sears that before receipt of an e-mail on 20 May 2004 from Ian Moules, of Excise Policy, the section of which he was head was unaware of the existence of FOBT-like section 16/21 machines with RNGs outside the machine and that he did not recall such machines being mentioned before by any assurance officer and there was nothing to indicate this in documents which he had seen.
63.	However, even if, contrary to our earlier conclusion at paragraph 53, the relevant knowledge of the United Kingdom is limited to that of Customs and Excise, we do not consider that the knowledge of the Commissioners can be confined to that of the Policy departments.  On the evidence before us 5,000 stamp machines were in use before stamps lost their popularity.  Thomas Estate held 47 section 16 licences from March 2003 and Stanley Casinos had 30 Cadillac Jack machines in November 2003.  These are only some of the machines in question. We are satisfied on the balance of probabilities that VAT assurance officers on visits must have been aware that traders were using exempt machines.  Any other conclusion would have been a serious reflection both on the competence of such officers and on their managers.  Quite apart from Customs officers concerned with VAT assurance, other officers concerned with ensuring that the correct excise duties were being paid must have been aware of the machines even if they did not know of their VAT treatment which would appear surprising.
64.	In our judgment the fact that Mr Sears and his department were unaware of the existence of exempt comparators before 2004 itself involves a failure by Customs and Excise and thus the United Kingdom to exercise due diligence.  This conclusion is not intended to be a reflection on Mr Sears and his department.  His evidence was effectively that his responsibility was to give advice or rulings when asked. He told us that he had no authority to give instructions for visits to be made to collect information.  The allocation of responsibilities within Customs and Excise was presumably a matter for the Board.  If there was any person or department other than Mr Sears and his team with responsibility for ensuring that the United Kingdom complied with the requirement for fiscal neutrality with respect to the gaming exemption there was no evidence to that effect.  Nor was there evidence that anyone in the Treasury had such responsibility.
65.	If the knowledge of the problem did not reach anyone with the power or responsibility to address the problem of fiscal inequality before 2004 it inevitably followed that no action could be taken until then.  We turn now to what happened when the question of differential treatment became apparent.
The action to remedy the differential treatment
66.	The problems facing the Respondents went far beyond the simple question of what action to take to remedy the differential treatment of slot machines.  Following the decision of the ECJ in Fischer it was known that the conditions and limitations laid down by Member States to the gambling exemption under Article 13B(f) must not conflict with the principle of fiscal neutrality. There was of course in the present case a dispute which is being resolved in the present litigation as to whether there were exempt activities which were comparators to taxed activities or machines.  It was not, however, suggested by Mr Vajda that such dispute could itself have given rise to a due diligence defence.
67.	The primary initial problem arose out of FOBTs.  We have already referred to the question whether FOBTs involved betting rather than gaming (or games of chance).  Although exempt from VAT, betting attracts a substantial duty on gross profits.  Although in purely financial terms this to a large extent offset the exemption from VAT, it is no answer to the need for fiscal neutrality in VAT, see paragraphs 29 and 30 of the opinion of the Advocate General in Fischer [1998] STC 708.  A change in the treatment in FOBTs did however in practice involve compensating changes in betting duty. Another problem arose from the fact that the exclusion from the VAT exemption, by reason of the definition of gaming machines, reflected the definition of gaming machines in section 26 of the Gaming Act 1968.  The Gaming Act was expected to be replaced shortly by the Gambling Act 2005.  There were also problems as to the possible amendment of the Amusement Machine Licence Duty regime.  All of those problems faced policy-makers.
68.	In July 2003 Customs had published a Consultation paper on the review of Amusement Machine Licence Duty headed, “The Modernisation of Gambling Taxes”.  This invited general comments on AML duty and VAT on machines and alternative approaches.  The responses including those of the Appellant opposed replacement of VAT on machines by gross profits tax; there was no suggestion in the responses that FOBTs were similar to gaming machines and no representations as to section 16/21 machines.
69.	Whatever knowledge Customs officers had or ought to have had before March 2004, it is undisputed that Customs knew by that date that section 16/21 machines were in use quite apart from FOBTs.  On 26 March 2004 advice was sought from the Solicitor’s office by Ian Ayre on the VAT liability of machines supplied in betting offices on the one hand and amusement arcades, bingo clubs and casinos on the other; this covered section 16 and 21 machines.  The advice given on 21 April and 12 May was not disclosed as being privileged.  An e-mail by Robert Bartlett, of the Solicitor’s Office, dated 1 June headed, “Differential treatment of FOBTs and gaming machines” was however produced.  In this he wrote that he agreed
“that gaming machines cannot be treated differently depending on where they are sited” and wrote, “My suggestion for treating machines differently … was based on the premise that [FOBTs] in licensed betting offices are not gaming machines.  Conversely, machines that resemble such terminals (but are not sited in licensed betting offices) are gaming machines not [FOBTs] see paragraph 14 of my advice dated 21/4/04.”
He added,
“For so long as it remains in the interests of those who operate them to assert that these machines are different, a challenge to their differential treatment looks unlikely.  I would not, however, expect this distinction to survive a challenge before a court or tribunal.” 
The e-mail referred to Linneweber (in which the oral hearing had just taken place) and expressed the opinion, which proved correct, that the Court of Justice would not depart from its reasoning in Fischer.
70.	The e-mail on 20 May 2004 from Ian Moules, of Excise Policy, to which we have referred at paragraph 62 above referred to the existence of FOBT–like section 16/21 machines with RNGs outside the machine.  The e-mail said that there was considerable doubt as to whether they were in the VAT net.
71.	Between 2 June and 8 June 2004 there were 10 more e-mails between officers concerned with VAT Policy and Excise Policy with the same heading as Mr Bartletts’ e-mail of 1 June, “Differential treatment of FOBTs and gaming machines”.  On 3 June Mr Ayre e-mailed Mr O’Kane stating that the bookmakers were content because they had agreed to suspend the litigation with the Gaming Board and continued,
“The s. 16/21 operators are similarly content as they see those machines as an innovation which enable them to compete with the bookmakers.  In addition they are being marketed as not being subject to licence requirements or VAT.”
On 7 June Mr Sears e-mailed Mr O’Kane expressing concern at the different treatment of FOBTs depending on their location.  He wrote,
“My own view is that FOBTs are gaming machines as defined in the VAT Act and therefore should be subject to VAT.”

On the same day Ian Moules e-mailed Mr Sears,
“While I can appreciate your desire for equality, I am not sure that this is the right time to try to resolve the outstanding issues.  As you will be aware, the Govt … plans to introduce a Gambling Bill in the autumn.  By revising the definition of gaming machines, the Bill should solve some of the problems we currently face.  This should also help us move forward the reform of gaming machine taxation … .  This would seem to be the ideal time to regularise the tax treatment.”
72.	Mr  Sears replied to Mr Moules on 8 June,
“This issue has now been hanging around for a long time and although we had resolved the initial problem, it has arisen again because of the spread of these machines.
“The bottom line in my view is that we can’t have a difference in treatment depending on location as this is contrary to the ECJ decision in Fischer.  Therefore, the simple question to be answered is whether we want to charge the machines with VAT and AMLD or with GPT” (gross profits tax).
On the same day Mr O’Kane e-mailed Mr Sears,
“In an ideal world those would probably all be taxed as gaming machines but, while intuitively we all agree that those things are providing games of chance, they do not appear to fall within the current definition of gaming machine.
Unless we can identify a difference other than location then I agree that excise and VAT need to work together to agree the future treatment.”
Again on 8 June, in a postscript to an e-mail to Mr O’Kane, Mr Sears wrote,
“I’m having major feelings of déjà vu here – these are all issues we’ve covered to death on a number of occasions in the 12 months I’ve been here.”
73.	In a letter to Mr Sears dated 10 June 2004 directed to the taxation of FOBTs and the like, Mr O’Kane wrote that VAT Policy felt confident that FOBTs were within the VAT definition of gaming machines and were not exempt whereas, for excise legislation, FOBTs with remote RNGs were not gaming machines.  He wrote,
“10.	Our legislation is deficient: it has been outwitted by technological developments but we recognise this and intend to remedy it.  I understand your concerns about adopting an inconsistent application of VAT liability (under the terms of VATA and 6th Directive) but to take a consistent approach for VAT would require inconsistent application of Excise and Social law and this is very likely to expose VAT Policy to a legal challenge.
“Conclusion
11.	It seems that we cannot avoid going against some piece of law and are faced with a choice between:
•	Operating within the current excise and social constraints until Budget 05, which seems to go against the concept of fiscal neutrality and might see some sector challenging us on that basis; or
•	Ignore what excise legislation actually says and apply taxation on the basis of VAT definitions, which is more likely to provoke a legal challenge.
“12.	Whichever route we take we will need to advise Treasury of our intentions and seek approval to disregard some piece of law.  I don’t really think this is something we can do without Ministerial agreement …  Strict adherence to the law should always be the preferred option but I think that a Treasury-sanctioned ‘fudge’ might be the most pragmatic, short-term solution in this case.”
74.	At a meeting with BACTA on 14 July 2004 concerning section 16/21 machines it was stated that these were to be re-categorised as gaming machines.  Customs were told that there were not many of such machines because they were very expensive and there was no guarantee as to their longevity. A note by Customs recorded Mr Simon Thomas as saying that the number of machines was in the low hundreds; the note was not sent to BACTA and Mr Thomas denied having said this.  The issue appeared to be over the word “low” rather than “hundreds”.  The note recorded that Mr O’Kane advised that, if numbers remained at their present levels, pending the Gambling Bill Customs were prepared to live with the present position.  The meeting was concerned with the fact that no licence was required for these machines because they were not gaming machines.  There was no mention of fiscal neutrality or equal treatment.
75.	A submission to the Economic Secretary to the Treasury dated 7 September 2004 recorded that in the 2004 Budget the Chancellor had indicated that major reforms of gambling taxes would be deferred to align with the Gambling Bill which was expected to be introduced in mid-October 2004.  The submission recommended delaying tax legislation to 2006 using the 2005 Budget to legislate for more urgent issues.  It stated at paragraph 14,
“… it would be extremely difficult for us to translate decisions on the post-deregulation tax framework in time for the next Finance Bill.”
In the next paragraph it was stated that a stand-alone system of tax law,
“would probably involve creating new definitions of gambling products and activities specifically for tax purposes which might later prove to be inconsistent with the new social law.”
At paragraph 25 this appeared,
“FOBTs.  The Gambling Bill will reclassify FOBTS as gaming machines …  In recent months we have seen the emergence of FOBT look-alike machines in bingo clubs and adult gaming centres which are exploiting the social law (section 16 of the Lotteries and Amusements Act 1976 and Section 21 of the Gaming Act 1968).  At present they do not seem to be very popular and we do not believe that there is a pressing need to amend the excise definition of gaming machines ahead of the changes proposed by the Gambling Bill.”
The submission made no reference to the problem arising from the differential treatment of FOBTs and gaming machines or to the case of  Linneweber in the Court of Justice.
76.	In the same month, September 2004, a business brief was issued by the Greenock Accounting Centre handling amusement machine licences.  It was headed, “Duty liability for section 16 and section 21 Gaming Terminals.” The brief stated, “These terminals have become increasingly popular in gaming premises, particularly bingo clubs and arcades.”  The machines were described as follows:
“These terminals look like traditional gaming machines and are similar to bookmakers fixed-odds betting terminals.  They offer games of chance, usually roulette-based games, and are driven by a remotely sited, random number generator.  They have a maximum stake of 50p, a maximum cash prize of £25 and can also offer non-cash prizes.  In bingo clubs, the non-cash prizes are restricted to a maximum value of £500.”
It was stated that the terminals were liable to £250 licence duty for 12 months as Category A machines and that if they provided games of chance their takings were exempt from VAT.  It was stated that those who did not already hold a Category A licence must notify the Accounting Centre of the number of machines and the date on which they were obtained.
77.	Internal guidance to officers (VI-07) issued in January 2005 stated that section 16 and section 21 terminals were similar to bookmakers’ FOBTs, offering games of chance, usually roulette-based and being driven by remotely sited RNGs.  It contained the following,
“Because the element of chance is not provided by the terminals themselves, but by an RNG which is outside the machine, both bookmaker’s FOBTs and Section 16 and Section 21 terminals cannot be treated as gaming machines.  Consequently, if the terminals offer the facilities for the placing of bets or for playing any games of chance, they will be exempt from VAT …”
Mr Sears’ team were unaware that there might be section 16/21 machines with RNGs outside the machines but in the same premises.
78.	On 26 January 2005 Mr O’Kane sent an e-mail to Mr Sears which included this,  
“… DCMS might introduce a late amendment to their bill that would unequivocally treat FOBTs as gaming machines and allow them to be sited in casinos.  If this were to be the case we would find ourselves in a hole : casino operators are not bookmakers (so no [betting duty]), FOBTs don’t fall within the definition of dutiable gaming (so no gaming duty), these are not gaming machines for AMLD purposes and we needed some confirmation about their status for VAT.  If a DCMS amendment were to allow those things into casinos we would be forced to make changes to gaming machine definitions.
“It doesn’t now seem that changes will take place to this extent so it’s less likely that we need to act in this budget.”

79.	A further Treasury submission to the Economic Secretary dated 8 February 2005 recommended that there was no need to change the taxation of FOBTs in the Budget and in view of uncertainty about the Gambling Bill advised against announcements on gambling taxation.  Annex C on Amusement Machine Licence Duty contained this,

“3.	The popularity of FOBTs in betting shops has had a significant impact on the industry. BACTA blame FOBTs for reducing the popularity of machines in other locations, particularly pubs, and consequently making these machines unviable.”
The submissions made no reference to the problem of fiscal neutrality or different taxation of similar machines.
80.	Following the decision of the ECJ in Linneweber on 23 February 2005, Customs received many voluntary disclosures by machine operators on the grounds that there was a difference in tax treatment of similar machines.  Mr Sears stated that in the majority of cases these were in a standard form and did not give details of the operators’ machines or how they compared with other machines.
81.	In a further e-mail to Mr Sears dated 11 May, Mr O’Kane informed him that the Gambling Act passed before the dissolution of Parliament for the election allowed the casino industry to have gaming machines with stakes of £15 and prizes of £500 to compete with FOBTs.  DCMS had “advised that those were not FOBTs but were simply high stake/prize gaming machines” which would be brought in by regulations under the Gaming Act 1968.  An attached e-mail said that there seemed to be two options if the view was taken that VAT ought to be applied equally to these machines and FOBTs.  Option 1 was to apply VAT and AMLD to FOBTs removing betting duty.  “This would probably go down like a lead balloon with the bookies – there’s been no consultation …”  Option 2 was to exempt these new casino machines from VAT.  He commented,
“If we amend VATA so that these casino machines are not gaming machines for VAT purposes then it seems to me that we would be removing all gaming machines from the VAT net, losing approx £200m/annum in VAT receipts.  This would not be acceptable …  I can’t see Ministers being happy with any of those.  I suppose there is a third option – do nothing immediately.  If [Solicitor’s Office] flag up a potential discrepancy we should advise [the Financial Secretary] and recommend that changes be made in [the Finance Bill 2006].”
82.	Mr Sears replied on 12 May stating “identical machines, whatever they’re referred to, have to be treated the same from a VAT point of view” and in a further e-mail also on the same day stated, “decisions/recommendations being made about changes to VAT legislation are for me to consider and take forward, no-one else!”
83.	Mr O’Kane replied on 12 May agreeing that all identical machines must enjoy consistent VAT treatment.  He wrote,
“… [T]he high stake/prize machines to be introduced into casinos will not be FOBTS: they will be gaming machines as per Part III of the Gaming Act 1968.  If those machines fall within the terms of Part III they won’t be identical to FOBTs (which fall outside the part III definition).
“On these bases we were fairly relaxed about DCMS’s plans – it was just another category of gaming machine.”

84.	There was a series of further e-mails on 12, 13 and 20 May.  These were followed by a Paper dated 22 June 2005 by HMRC (as it had become) and the Treasury to the Financial Secretary addressing the taxation of new FOBT style machines in casinos.  The paper exhibited contained substantial redactions.  Under “Summary” this appeared,

“”DCMS propose allowing the introduction of FOBTs in casinos from October/November this year.  There are some difficulties with their taxation position, particularly in relation to VAT neutrality issues.”
Under “Background” it was stated in paragraph 2,
“The Treasury was not consulted on these last-minute concessions, which went against our prior advice to DCMS …”
Paragraphs 3 and 4 included the following,
“3.	The difficulty on taxation arises because for the purposes of VAT law (mirroring the 1968 Gaming Act), FOBTs in bookmakers are not gaming machines … because the … RNG … is remote from the machine … 
4.	This would create a situation where we have differential VAT treatment of similar machines.  This would offend the Community law principle of fiscal neutrality …”

Paragraphs 5 and 6 referred to Linneweber.  Paragraph 8 set out four potential options : taxing FOBTs in casinos and bookmakers differently for VAT purposes for 9-12 months until wider reforms of machine taxation, delaying the introduction of FOBTs in casinos, exempting FOBTs in casinos from VAT and extending VAT to FOBTs in bookmakers.   At paragraph 14 the paper concluded that none of the above options was ideal but the first was preferable.  At paragraph 15 it was stated that Option 1 could be raised with the casino industry in advance.

“Making this clear in advance could minimise the risk of subsequent legal challenge.  On the other hand, it could draw attention to the issue and actually increase the risk of challenge …  On balance, we think it is better not to alert the industry and keep as low a profile as possible.  Do you agree?”

85.	At this stage VAT Policy did not appreciate that the newly permitted FOBTs in casinos would be similar to the Part III machines that were already in gambling premises.  Furthermore, those “casino FOBTs” were considered to be an entirely separate issue from the section 16/21 machines already on the market.

86.	Around June 2005 Customs officers in Scotland encountered the practice of removing RNGs from the terminals .

87.	On 5 September an e-mail from Mr Romanski, Mr Sears’ Deputy Director, referred to Linneweber and said that HMRC could be vulnerable to the same argument in respect of FOBTs because those in betting shops were not gaming machines because the RNGs were sited remotely whereas the RNG in casino FOBTs would be located within the machine. He wrote,

“This could be an issue because although we differentiate between the operation of the machines, to the average user, they look and operate the same.  A submission was put to Ministers on this in June (attached) but we have not yet had a reply.”

He then referred to a “potential VAT avoidance scheme” whereby the RNG is moved to a box outside the machine so escaping both VAT and excise duty.  He continued,

“I have seen, in this context, a suggestion that advisers are arguing that Linneweber means that traditional gaming machine takings should also now be exempt.  But I don’t see anything in Linneweber which stops us taxing all machines.”

88.	On 15 November 2005 Mr Romanski made a submission to the Financial Secretary recommending,

“That the definition of gaming machines which governs the scope of VAT in this area be clarified to ensure that it covers all machines used for gaming – effective from the day after [the Pre Budget Report].”

In paragraph 2 he stated that following Linneweber,

“Operators of taxable gaming machines in this country are submitting claims for refunds of the VAT they have paid over the last three years.  Claims submitted so far total just over £50 million, but the potential arrears of VAT at risk total around £700 million, with a continuing potential loss of £235 million per year going forward.”

The remainder of paragraph 2 was redacted.  Paragraph 3 read,

“3.	We therefore recommend changing the definition of gaming machines for VAT in PBR with immediate effect, to bring all machines used for gambling within the scope of VAT, protecting the VAT revenues from gaming machines for the future.  Acting now will cap potential losses and remove avoidance opportunities without prejudicing our ability to resist claims.”

At paragraphs 9 and 10 of the submission Mr Romanski stated that section 16/21 terminals had experienced rapid growth in 2005.  There was evidence of avoidance or manipulation with machines being reconfigured by removing the RNG to fall outside the definition of gaming machine so avoiding VAT and gaming machine rates of AMLD.  It was recommended that the definition of “gaming machine” be changed by Treasury Order under the affirmative resolution procedure at the Pre Budget Review.

89.	This recommendation was approved subject to the Chancellor’s agreement.  A draft statutory instrument with explanatory memorandum and regulatory impact assessment were submitted to the Financial Secretary on 30 November. Following the Minister’s approval the Statutory Instrument, the Value Added Tax (Betting, Gaming and Lotteries) Order 2005 (S.I. 2005, No. 3328) was laid on 5 December and came into force on 6 December 2005 substituting in Group 4 of Schedule 9 to the Value Added Act 1994 Notes (3) to (8) in place of Note (3).

90.	The Explanatory Memorandum for the Select Committee on Statutory Instruments included the following under Policy Background:

“7.1	Although most betting and gaming is exempt from VAT, the net takings of gaming machines are liable to VAT at the standard rate.  The definition of gaming machines for VAT only covers those machines where the element of chance in the game is provided by means of the machine.

7.2	The definitions of a gaming machine in VAT and excise law have traditionally followed those in the social law applicable to the different forms of gambling.  The social law definition has been updated by the Gambling Act to reflect new technology.  A new definition for VAT purposes that uses section 235 of the Gambling Act as a template is accordingly desirable.

7.3	Section 235 of the Gambling Act has not taken effect yet, because the requisite appointed day order has not been made. Bringing forward the adoption of the new definition of gaming machine (rather than waiting for section 235 to be brought into force) will have the effect of removing the scope for legal challenges based on an alleged breach of fiscal neutrality.

Following the judgment of the European Court of Justice in the case of Linneweber, that German VAT law contravened the European Community principle of fiscal neutrality by exempting gaming machines in casinos while taxing similar machines in other establishments, operators of taxable gaming machines in this country are submitting claims for refunds of the VAT they have paid over the last three years.

7.4	Bringing forward the adoption of the new definition of gaming machine will also clarify the VAT liability of machines whose random number generator is not located within the outer casing of the machine, in light of recent attempts at avoidance through reconfiguring machines, by putting it beyond doubt that the location of the random number generator is irrelevant.

At present one of the features that must be present for a machine to be a gaming machine is that ‘the element of chance in the game is provided by means of the machine’ (Note (3)(c) to Group 4).

7.5	We do not accept that the avoidance is successful, or that there has been any breach of fiscal neutrality, but this change in definition will ensure that there is little room for doubt that all machines used for gambling are within the scope of VAT.  It will thus protect VAT revenues from gaming machines for the future.

7.6	Although the new definition will have been implemented immediately by this Order, the similar definition of a gaming machine in section 23 of the Act can only be amended by primary legislation.  In the meantime, the provisions limiting the amount upon which VAT is charged will not apply to any machines that were not previously treated as gaming machines.  To deal with this anomaly, Ministers have announced that the Department will be collecting the VAT on only the net takings until the necessary clause in the Finance Bill 2006 is enacted.  It is proposed that the clause will be retrospective back to the date this order came into force.”

91.	The Regulatory Impact Assessment stated under “Competition Assessment”,

“…	This measure will aid competition as it puts all gaming machines on a level playing field”.

92.	In his statement for this hearing Mr Sears stated that the suggestion that either FOBTs or section 16/21 machines were similar to Part III machines for fiscal neutrality purposes only arose in late 2005, citing Mr Romanski’s e-mail of 5 September 2005.  He stated that it was not a possibility which occurred to anyone in HMRC during the emergence of either FOBTs or section 16/21 machines.  He said at paragraph 48,

“Once HMRC became aware of the concern with the tax treatment of Part III machines, and the attempted VAT avoidance using section 16 and section 21 that was considered to underpin the argument, the law was changed within three/four months at the next legislative opportunity i.e. the 2005 PBR.”

At paragraph 44 he stated that to minimise the burden on business and advisers,

“It is Government policy to make changes to tax law only at the time of the Budget or at the time of the PBR.”

93.	In our judgment, quite apart from FOBTs, even when Customs and Excise became aware of the existence of exempt comparators in the form of section 16/21 machines the United Kingdom did not act with sufficient speed to amend the law to ensure compliance with the principle of fiscal neutrality.  This was in part due to the quite separate problems raised by the Gambling Act and the treatment of FOBTs.  In March 2004 legal advice was sought on the liability to VAT of section 16/21 machines.  The response was not disclosed on grounds of privilege.

94.	The submission to the Economic Secretary dated 7 September 2004 recommended deferring action on section 16/21 machines to 2006 stating that the machines did “not seem to be very popular”.  However in the same month a business brief stated that section 16/21 terminals “have become increasingly popular in gaming premises, particularly bingo clubs and arcades.”  The decision of the Court of Justice in Linneweber was given on 17 February 2005. No action was taken in the 2005 Budget or in the Finance (No.2) Act 2005 which passed into law on 20 July 2005.  

95.	The fact that it is government policy to make changes in tax law only at the Budget or the pre-Budget report is a matter of choice which has not been consistently followed.  We note that two statutory instruments Numbers 1931 and 1933 of 2004 were laid amending VAT law on 22 July 2004 to come into force on 1 August 2004.  The amendment to section 80 of the Value Added Tax 1994 capping repayment claims to 3 years was announced on 18 July 1996 and enacted in the Finance Act 1997 with effect from the announcement.

96.	In our judgment, even if, contrary to our decision, FOBTs were not comparators and the relevant knowledge was that of the policy departments of Customs and Excise, the United Kingdom did not act with due diligence to remedy the situation.  On the basis of our conclusion that FOBTs were relevant comparators and that the relevant knowledge for the purposes of due diligence included both the Gaming Board and also Customs assurance officers the case is even stronger.  We conclude that the facts necessary to found any defence of due diligence have not been established.

Summary of conclusions

97.	We summarise our conclusions as follows:	
(1)	The decision of the ECJ in TNT does not have the effect that supplies under different regulatory regimes are in principle not similar for fiscal neutrality purposes.  The differences between the regimes for section 16/21 machines and Part III gaming machines and those for FOBTs and Part III were not overriding and were merely a factor in deciding whether the supplies had similar characteristics and met the same needs from the point of view of consumers (paragraphs 22 and 23).

(2)	The Tribunal’s earlier conclusion that section 16/21 machines were similar to part III gaming machines is unchanged (paragraphs 24 and 25).

(3)	From the viewpoint of the generality of players FOBTs and Part III gaming machines were similar (paragraphs 33 to 38 and 50).

(4)	Various machines within either section 16 or section 21 were in commercial use from the late 1970s until the late 1980s in the case of stamp machines, in 1984 in the case of Express Racing, from early 2002 in the case of Bingo Royale and Jackpot Bingo, from November 2003 in the case of Casino King and Cadillac Jack and from early 2004 in the case of Jackpot Roulette.  Exempt comparators were therefore in commercial use for the entire period covered by the claim (paragraphs 40 to 47).

(5)	FOBTs were in commercial use from 1998 (paragraph 48).

(6)	There is in law no defence of due diligence to an infringement of fiscal neutrality (paragraph 51).

(7)	The obligation to comply with the Sixth Directive was an obligation on the United Kingdom.  The relevant knowledge for any defence of due diligence was not limited to Customs and Excise, nor HMRC, but included the Gaming Board (paragraphs 53 and 63).

(8)	The Gaming Board knew of all the comparator models with the possible exception of Express Racing, the earliest being Green Shield stamp machines which were in use before 1980 (paragraphs 40 and 60).

(9)	Customs knew of FOBTs at all relevant times (paragraph 61).

(10)	Customs policy officers knew of section 16/21 machines in the first half of 2004 however assurance officers must have been aware of them earlier although their significance was not recognised (paragraphs 61-63)

(11)	The fact that policy officers were unaware of exempt comparators before 2004 itself involved a failure by Customs, and thus the United Kingdom, to exercise due diligence (paragraph 64).

(12)	Even when Customs became aware of the existence of exempt comparators other than FOBTs the United Kingdom did not act with due diligence to ensure compliance with the principle of fiscal neutrality (paragraphs 93-96).

(13)	The appeal is allowed for the entire period covered by the claim.

THEODORE WALLACE
TRIBUNAL JUDGE
RELEASE DATE: 11 December 2009