Does dishonesty have to be proved when alleging knowledge of VAT fraud connected with transactions?

Tue 31 Oct 2017

The Court of Appeal has held that HMRC can challenge a taxpayer’s right to deduct input VAT on the basis the taxpayer knew, or should have known, that its transactions were connected with the VAT fraud, without having to plead, particularise and prove an allegation of the taxpayer’s dishonesty.

In cases such as this concerning missing trader intracommunity (MTIC) VAT fraud, it is necessary to consider the Kittel test. The Kittel test arises from the decision of the Court of Justice of the European Union (“CJEU”) in the case of Axel Kittel v. Belgium; Belgium v. Recolta (C-439/04 and C-440/04), [2008] STC 1537 (the “Kittel” case). It provides that a trader will not be able to reclaim input VAT if it knew or should have known that the transaction in which it was involved was connected with a scheme for the fraudulent evasion of VAT, which involves two limbs. Demonstrating actual knowledge is the first limb of the Kittel test, whilst demonstrating that the taxpayer should have known has been referred is the second limb.

The Court of Appeal case concerned two taxpayers. E-Buyer is a large on-line retailer of electronic products and HMRC had refused it input VAT recovery of £6.7m concerning trades between June 2010 and September 2011 involving defaulting traders.  The other taxpayer was Citibank concerning its involvement in the purchase and sale of EU emissions allowances in September 2009, for which it had been assessed to £9.9m for recovery of input VAT in respect of MTIC.  In both cases HMRC alleged the taxpayers had actual knowledge of VAT fraud.

Earlier the FTT had held that HMRC were required to allege dishonesty to pursue their claim against Citibank (which HMRC did not want to do). In the case of E-Buyer the FTT had held that HMRC’s statement of case was sufficient for the case to go ahead, notwithstanding that HMRC had not formally alleged dishonesty.  The UT considered that while the Kittel test did not require dishonesty to be present for either of the limbs to be proved, the cases of HMRC against both Citibank and E-Buyer did amount to allegations of dishonesty and this needed to be pleaded for both cases to proceed.

The Court of Appeal unanimously agreed with HMRC that the UT was wrong to conclude that an allegation, made under the first limb of Kittel, that a taxpayer knew that its transactions were part of an orchestrated scheme to defraud HMRC, required a pleading of dishonesty. In the Court of Appeal’s view actual knowledge should not be equated with dishonesty, which was what the UT did, despite acknowledging that it should not be done.

This case may be of interest bearing in mind that FB 2017-19 clause 69 introduces a new penalty for satisfying the Kittel test (either limb) of being involved with a transactions connected with VAT fraud. The penalty is 30% of the potential VAT lost and can, in some circumstances be transferred from the business to the officers of that business, with publication of the names of those receiving penalties where the potential lost VAT exceeds £50,000.  The measure will be effective from the date FB 2017-19 receives Royal Assent, which should be before Christmas.