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19/05/20

VAT Assessment | Kittel Principle in HMRC Cases

VAT Assessment | Kittel Principle in HMRC Cases
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Many businesses will receive a Notice of VAT Assessment and Penalty Notice from HMRC during the course of their existence.

One such Notice of VAT Assessment from HMRC is based on the Kittel Principle.

In this article, Hamraj Kang of KANGS discusses VAT Assessments served on the basis of the Kittel principle.

What is the Kittel Principle?

The Kittel principle is often cited by HMRC to deny a taxable trader the right to claim input tax on certain transactions.

In reality, by the time HMRC serve the Kittel Notice, the trader will have already claimed the input tax on the transactions and the Kittel Notice requires the trader to repay that money to HMRC. Invariably, the sums are large and the trader does not have the resources to pay the demand from HMRC.

The European Court of Justice (’ECJ’) judgement in the case of Axel Kittel & Recolta Recycling SPRL established the Kittel principle which states that a taxpayer who claims input tax on transactions which he knew or should have known were connected with fraudulent evasion of VAT should be denied his right to claim that input tax.

The Logic Behind the Kittel Principle

The ECJ made it clear that if a taxable trader, at the point of his purchase, either knew or should have known that he was taking part in a transaction connected with the fraudulent evasion of VAT, that taxable trader must be regarded as a participant in that fraud. It did not matter whether the taxable trader made a profit or not on the resale of the goods.

The ECJ stated that the taxable trader in this situation is aiding the perpetrators of the fraud and is effectively becoming their accomplice.

Based on this interpretation, we have represented a number of taxable traders who have, unbeknown to them, been part of a suspect trading chain. These ‘innocent’ traders have been served with VAT Assessment Notices under the Kittel principle. 

The Three Limbs of the Kittel Principle

The Kittel principle can be divided into three limbs:

  • Was there fraudulent evasion of VAT?
  • Was the transaction ‘connected with’ that fraudulent evasion of VAT?
  • Did the taxable trader, when he entered into the transaction, know or should have known that it was ‘connected with fraudulent evasion of VAT’?

In relation to limbs 1 & 2 above, a HMRC investigation often concludes that the transactions in question can be traced back to identified fraudulent tax losses and that those transactions are connected to a VAT fraud and/or tax loss.

The taxable trader is entitled to take issue with the HMRC findings in relation to limbs 1 & 2 above and often HMRC is put to strict proof of the fraudulent tax loss.

In our experience, the real ‘battleground’ and therefore an area of major dispute between HMRC and a taxable trader, relates to limb number 3 above, namely the need to show that the taxable trader ‘knew or should have known’ that the transactions were ‘connected with fraudulent evasion of VAT’.

What Does ‘knew or should have known’ mean?

The ECJ did not define what ‘knew or should have known’ meant but confirmed that it was an objective test.

In order to show that the taxable person knew or should have known that the transactions were connected with fraudulent evasion of VAT, HMRC will look to gather evidence in support of its case including:

  • what did the taxable person know about fraud in general at the time the transactions in question took place?
  • are there any features relating to the transactions that would have led the taxable person to question if the transactions were connected with fraudulent evasion of VAT?
  • what due diligence did the taxable person undertake before entering into the transactions in question and was it sufficient/reasonable?

Who Does the Test for ‘knew or should have known’ apply to?

The courts have made it clear that the Kittel principle applies to the taxable person and therefore this can be a company.

If the taxable person is a company, it is separate and distinct from the company director(s).

The test is therefore, what did the company itself know or ought to have known? This is not the same as what did the company director(s) know or ought to have known.

The knowledge of the company director(s) will be attributed to the company but the company may also have other sources of information that the director(s) may not have been privy to such as the knowledge of employees, third parties who advise the company or act as agents for the company.

‘Knew’ – Does the Taxable Person Have Actual Knowledge?

In our experience, it is not usual for HMRC to uncover evidence of ‘actual knowledge’ on the part of the taxable person in such cases.

Depending on the nature of the evidence uncovered, HMRC may, for example, seek to infer actual knowledge if there is evidence that the transactions were conducted in such an unusual way that the taxable person must have known that the transactions were connected with fraudulent evasion of VAT.

HMRC often cite various characteristics of transactions that it claims bear the ‘hallmark’ of fraud including:

  • The lack of due diligence
  • Ignoring negative indicators from due diligence
  • Contrived nature of the trading such as fixed suppliers/profit margins
  • Inadequate insurance for products being traded
  • New companies with a lack of trading history
  • Unsolicited approaches from unknown entities
  • Third party or off-shore payment requests

The Only Reasonable Explanation

The Court of Appeal has confirmed in Mobilx Ltd (in administration) & Others [2010] that the Kittel principle covers not only those who know of the connection to fraudulent evasion of VAT but also those who should have known.

The Court of Appeal confirmed that if a taxable trader should have known that the only reasonable explanation for the transaction in which he was involved was that it was connected to fraud (and it turns out that the transaction was connected to VAT fraud) then he should have known of that fact. This makes the taxable trader a participant in the fraud for the reasons explained in the Kittel case.

An example where the court could conclude that the only reasonable explanation for the circumstances in which the transaction took place was that it was a transaction connected to the fraudulent evasion of VAT would be where:  

  • A taxable trader enters into a transaction which appears to have very favourable and generous terms, and
  • It turns out that the transaction is connected to the fraudulent evasion of VAT
  • But at the time of entering into the transaction the taxable trader did not exercise enhanced caution by conducting a more detailed due diligence/risk assessment nor did the trader refrain from conducting the transaction
  • But instead the trader ignored the risks and continued with the transaction

General Level of Fraud Awareness

HMRC will investigate a taxable person’s general level of fraud awareness as part of any investigation based on the Kittel principle.

HMRC may seek to show that the taxable person ought to have known by looking for evidence of the taxable person’s knowledge and awareness of fraud in general as well as the taxable person’s awareness of fraud specific to the market or sector in which the transactions in question have taken place.

Common features that HMRC will examine include:

  • Any record (written or verbal) of previous warnings given by HMRC to the trader regarding the dangers of MTIC/VAT fraud in his sector
  • Any record of the trader acknowledging such warnings and confirming his understanding of them
  • General press coverage of VAT fraud
  • Coverage in trade magazines, website and other publications of the dangers and characteristics of VAT/MTIC fraud specific to the market in which the trader operates
  • The frequency of HMRC warning notices received by the trader relating to suspect transaction chains
  • Any personnel working at or associated with the taxable trader (such as a consultant) previously identified as having involvement with suspect transaction chains resulting in VAT loss

A Reputation Built on Trust and Expertise

Since 1997 we have been here to assist our clients, both established and new ones, and to provide positive solutions to whatever VAT issues that may arise.

We use our considerable knowledge and experience to guide clients through the minefield of MTIC fraud and VAT Fraud allegations.

We instil a sense of calm in our clients, provide forthright and frank advice, and above all, provide our clients with practical solutions.

How Can We Help?

Hamraj Kang leads an award-winning team of solicitors nationally reputed for its excellence in KittelMTIC and VAT cases of every nature.

Our team of lawyers is available to meet at any of our offices in London, Birmingham or Manchester or, alternatively, we are happy to arrange meetings via video conferencing. If you need assistance, the Team at KANGS are here to help. We welcome new enquiries, simply contact us using the details below:

Tel:       0333 370 4333

Email: info@kangssolicitors.co.uk

We provide initial no obligation discussion at our three offices in London, Birmingham, and Manchester. Alternatively, discussions can be held through live conferencing or telephone.

Hamraj Kang

Hamraj Kang
Senior Partner

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John Veale

John Veale
Partner

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Tim Thompson

Tim Thompson
Partner

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