VAT fraud – Kittel denial of input tax by the HMRC
This article is written by Mr Shahzad Tariq, Tax solicitor dealing with certain tax issues. Mr Tariq is the Head of Immigration and Litigation at West London Solicitors. You can contact Mr Tariq directly on tariq@westlondonsolicitors.com
Notification of tax losses
The HMRC will usually provide you with a list of your supplier(s) whom have failed to meet its VAT liabilities. It is quite possible that the notice was issued as a result of enquiries the HMRC have conducted where they have identified transactions in your supply chain resulting in a loss to the public revenue.
Your next step
You should not ignore the HMRC notification. It is in your best interest to immediately undertake an audit of your suppliers. You should engage with the HMRC and show them steps you are taking to minimise the risk of such instances recurring in the future. You should provide evidence that you have carried out a meaningful due diligence of your suppliers.
HMRC is not satisfied
Your right to deduct input tax in respect of the transactions identified by the HMRC will be denied and the HMRC will issue adjustments to your VAT returns resulting in liabilities in the form of the principal amount, late payment and default interest and penalties. If the business is incorporated under the Companies Act 2006 as a private company with limited shares, a personal penalty notice will most likely be issued against the company director(s). This will likely be done under the Kittel principle.
The Kittel denial of input tax
The entitlement to the right to deduct input tax, and hence the entitlement to the right to repayment where input tax exceeds output tax, is fundamental to the operation of the VAT system. This is established in UK law through Value Added Tax Act 1994 “(VAT A94”), sections 24, 25 and 26, and Regulation 29 of The VAT Regulations (SI 1995/2518).
If a taxable person has incurred input tax that is properly allowable, he is entitled (subject to certain rules) to set it against his output tax liability and, if the input tax credit due to him exceeds the output tax liability, claim a repayment.
However, a taxpayer who claims input tax on transactions which he ‘knew or should have known’ were ‘connected with fraudulent evasion of VAT’, is to be denied his Community law entitlement to the right to claim that input tax.
This principle is set out in the European Court of Justice (ECJ) judgment in the case of Axel Kittel & Recolta Recycling SPRL (Kittel). The ECJ in its judgment (issued 6 July 2006) stated:
“… a taxable person who knew or should have known that, by his purchase, he was taking part in a transaction connected with fraudulent evasion of VAT must, for the purposes of the Sixth Directive, be regarded as a participant in that fraud, irrespective of whether or not he profited by the resale of the goods.”
That is because in such a situation the taxable person aids the perpetrators of the fraud and becomes their accomplice.
The Kittel principle can be broken down into three ‘limbs’, as follows:
- Was there fraudulent evasion of VAT?
- Was the transaction ‘connected with’ that fraudulent evasion of VAT?
- Did the taxable person, when he entered into the transaction, know or should he have known that it was ‘connected with fraudulent evasion of VAT’?
The HMRC will have to provide you with an explanation of how your case falls under the Kittel principle.
Time limits
The normal time limits for assessing are contained in section 73(6) of VAT A94”. They are as follows:
(a) 2 years after the end of the prescribed accounting period; or
(b) one year after evidence of facts, sufficient in the opinion of the Commissioners to justify the making of the assessment, comes to their knowledge.’
These are commonly known as the ‘two’ and ‘one’ year rules.
The four-year rule in section 77(1)(a) works in a similar way to the two-year rule except that in order to be able to assess as far back as four years, an assessment must be made and notified within the one year of evidence of fact time limit set out in section 73(6)(b).
Note: The author acknowledges that the source of information is https://www.gov.uk/ website. Additionally, the article contains public sector information licensed under the Open Government Licence v3.0.
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