The case followed an earlier VAT tribunal ruling that an escort agency was unlawful and therefore could not be taxed.
The tribunal said the business "consists wholly, or at least very substantially, of the procurement of women for the purposes of their becoming common prostitutes".
When the tribunal found that the agency was "straightforwardly criminal", it meant that Customs and Excise could not claim VAT.
The owners had always claimed their business was lawful but said their turnover was below the threshold for VAT. But the judge overturned the ruling. He said: "I conclude that this case is not within the very narrow rules which allow moral scruple by a paradox to reward criminality by exempting it from taxation."
Under EU harmonisation of taxation, VAT is payable on a wide range of services without any difference being drawn over whether it is legal or illegal. Only drug dealing and counterfeit money apparently escape being taxed.