Did you know or should you have known? That is the question…

17 July 2020


Aspire blogs on one of the most prevalent questions posed by HM Revenue and Customs (“HMRC”) to various businesses situated within temporary labour supply chains – did a business know, or should they have known, about a VAT fraud within its supply chain?

VAT fraud or the evasion of VAT has been a rife point of investigation for HMRC in many sectors, and we are constantly seeing the threat of HMRC utilising the “Known or Should Have Known” principle in labour supply chains. The principle, often referred to as the “Kittel Principle” (see HMRC’s internal guidance on Kittel here), utilises the caselaw initially established in in Missing Trader Intra Community (‘MTIC’) Fraud cases. This enables HMRC to disallow input tax recovery by entities in supply chains who purchase labour supplies without undertaking sufficient checks to satisfy themselves that the supplies are genuine and do not involve VAT fraud.

The below cases give an interesting insight into how HMRC are actively tackling VAT fraud in various supply chains using the Kittel Principle. It is important to remember that HMRC are using the Kittel Principle widely and even if you do not consider your business is at risk, wherever HMRC can prove:

  1. There is a tax loss in a supply chain (of any sort – goods or services),
  2. The tax loss can be linked to the fraudulent evasion of VAT,
  3. A taxpayer’s transactions are connected with that tax loss, and
  4. You knew or should have known about the fraudulent evasion of VAT

then HMRC can and will raise an assessment denying any input tax claimed against the taxpayer.

HMRC and Beigebell

  • This is an appeal in the Upper Tribunal (“UT”) against a decision made in the First-Tier Tax Tribunal (“FTT”) which allowed the taxpayer’s appeal against HMRC’s decision to deny input tax in the sum of £144,628.40.
  • Beigebell’s business activity included the supply of promotional merchandise, such as stickers, bags, T-shirts, notebooks and mouse mats to companies. In its VAT period 10/15 it made six purchases of memory cards from a single supplier, Online Distribution Limited (“ODL”), and sold them in five transactions to Hi View Trading SL (“HVT”), a company incorporated in Spain.
  • HMRC formed the view that Beigebell’s purchase of the memory cards was connected with the fraudulent evasion of VAT and that Beigebell either knew, or should have known, of that connection.
  • The FTT allowed the appeal on the basis that the director of the company, and therefore, Beigebell, did not know and should not have known that the transactions were connected with fraud when he entered into them.
  • HMRC appealed against the FTT’s decision to the allow the appeal.
  • The UT stated in its judgement that whilst the FTT had stated that it had “seen no evidence which proves or even suggests that Beigebell did in fact know that the transactions were connected with fraud”, the FTT had failed to address that there was clearly evidence which “suggested” that the director of Beigebell knew the transactions were connected with fraud. The factors which led to the suggestion included; the contrived nature of the transaction, inadequate contractual documentation and due diligence.
  • The FTT’s statement that there was “no evidence” meant that HMRC were able to appeal against the FTT’s decision on the ground that it did not properly understand the case.
  • The Upper Tribunal set aside the decision made by the FTT and sent it for reconsideration by the FTT as they considered there were errors of law in the FTT’s decision.

CCA Distribution Ltd (in administration) and HMRC

  • This is another set of proceedings which has been around the “carousel of the court”. The appeal concerns a taxpayer, CCA Distribution Ltd (“CCA”), who bought and sold goods, primarily mobile phones. HMRC allege the fraud perpetrated was a MTIC fraud and was at the route of the disputed transactions.
  • Interestingly, and importantly, the FTT did not consider that CCA seriously challenged the existence of a MTIC fraud. There was some challenge about whether one of the contra-traders was involved in the fraud but so far as the FTT understood, CCA did not dispute the existence of the underlying MTIC fraud.
  • MTIC fraud is designed to create a situation where tax repayments are due, or at least appear to be due, from HMRC. This particular type of MTIC fraud relies on engineering purchases and sales of goods from the UK to another EU country in order to trigger a repayment of VAT from HMRC.
  • In 2007, HMRC notified CCA that they would not be entitled to claim the input tax incurred on its transactions in the VAT periods 04/06 and 05/06, which amounted to £6,320,368.
  • In a second decision made by HMRC, CCA were notified that they would not be entitled to claim the input tax incurred on its transactions in the VAT period 06/06 also, which amounted to £3,553,886.54.
  • HMRC believed that all of CCA’s deals were connected to fraud and that its sole director knew or should have known this.
  • CCA appealed both of HMRC’s decisions in time which were later consolidated into one appeal. CCA had ceased trading in June 2006 and subsequently entered into administration.
  • The initial appeal in the FTT was heard in 2012 and the Tribunal’s decision was released over a year later in 2013 which upheld the appeal by the chairman’s casting vote.
  • In September 2015, the UT allowed HMRC’s appeal against the decision made by the FTT and set aside this Tribunal’s decision. The case was remitted to a differently constituted panel in the FTT on the grounds that at the first hearing errors of law had been made when concluding certain facts – CCA also appealed the decision made by the UT.
  • Seven years after the original hearing, directions were issued and in 2019, the FTT was able to hear the case once again.
  • HMRC alleged that all subjective transactions were orchestrated by fraudsters for the purposes of MTIC fraud.
  • The burden of proof was on HMRC, as with all allegations of fraud, who produced extensive evidence to allude to the fact that the director knew or should have known that the company was involved in a fraudulent supply chain.
  • The FTT found HMRC’s evidence convincing. The director of CCA gave evidence but the FTT found that his evidence lacked credibility. The FTT considered that the director was evasive and did not answer questions put to him
  • The FTT concluded in the rehearing that the Appellant did know about the VAT fraud and consequently dismissed the appeal.

Sandham trading as Premier Metals v HMRC

  • This appeal in the UT concerns the question of how the Kittel principle applies where the transactions in question were effected by a Partnership through an agent and, while the partners did not themselves know that the transactions were connected with fraudulent evasion of VAT, the agent did.
  • The Partnership was in the business of buying and selling of scrap metal and ventured into trading in more vulnerable “primary metals” some six years after the partnership began.
  • In VAT period 02/13 and its final VAT period (ending March 2013 – “99/99”) the Partnership entered into 56 transactions, involving the purchase and immediate resale of many primary metal. The company’s agent entered into these transactions on the Partnership’s behalf, although there was no scope of his authority to act as agent.
  • HMRC raised assessments in 2015 which denied the input tax claimed in relation to those 56 transactions resulting in an assessment of £1,930,951.
  • There was no dispute that the transactions linked back to a fraud, so it came down to the means of knowledge test. The FTT originally found that the agent knew of the fraud he was entering into and with that in mind the FTT directed that there were two tests to determine the knowledge of the Appellant in this case;
    • Whether the agent’s knowledge that the transactions were connected to the fraudulent evasion of VAT should be attributed to the Partnership so that when applying the Kittel test, the Partnership should be taken as knowing that the transactions were so connected (referred to as “Issue 1”)
    • Whether, if the agent’s knowledge was not attributed to the Partnership, did the partners themselves either know, or should they have known, of the fraud (“Issue 2”).
  • HMRC argued that the agent’s knowledge should be attributed to the Partnership and the FTT agreed, dismissing the Appellant’s appeal against Issue 1 and therefore determining that the knowledge of the agent in regards to the fraudulent transactions could be attributed to the partnership and the appeal against the input tax denial was dismissed.
  • Despite determining the position on Issue 1, the FTT did consider Issue 2 and concluded that neither of the partners themselves knew that the transactions were connected to the fraudulent evasion of VAT and although they failed to take reasonable care in questioning the agent’s activity with the disputed transactions, they did not have the means of knowing that the transactions were connected with the fraudulent evasion of VAT.
  • The appeal to the UT was allowed on the basis that the Appellant asserted that the FTT erred in law in concluding that agent’s knowledge was sufficient for the Kittel principle to apply.
  • The UT concluded that FTT was correct to conclude that, when applying the Kittel principle, the Appellants were to be attributed with the agent’s knowledge of the fraudulent transactions and the appeal was subsequently dismissed.

To summarise all of the above…

If a person enters into transactions that are connected with fraudulent evasion of VAT either knowing, or having the means of knowing, that the transactions were so connected, the person is not entitled to credit for associated input tax.

This is the Kittel principle and it can cost you, both financially and reputationally.

How can you protect your business against HMRC and a Kittel Assessment?

The first consideration to protect yourself and your business against a Kittel Assessment, is to ensure you know exactly who is in your supply chain.

Secondly, each of the judgements above highlighted one thing - the importance of carrying out extensive due diligence on your supply chain. Performing due diligence in an active and ongoing manner is the only way to have a defendable position, should HMRC raise an assessment to deny input tax on the basis of Kittel.

Whilst the burden of proof is on HMRC to prove that you knew or should have known that the transactions concerned were connected with the fraudulent evasion of VAT, a lack of sufficient due diligence procedures will make it far easier for HMRC to scrutinise an individual’s knowledge and approach in taking “reasonable care” when making business decisions.

Not only is there a risk of a business having its input tax claim denied and an assessment raised, the financial risk is also placed on any directors, office holders or managers who HMRC can prove knew or should have known about the fraud. Where HMRC considers it necessary, a penalty can be levied against individuals personally via a Personal Liability Notice which can be 30% of the denied input tax.

If you want to discuss your Supply Chain Management and Due Diligence processes before it is too late give us a call on 0121 445 617 or email enquire@aspirepartnership.co.uk.