VAT fraud can destroy a business, but relationship vigilance can keep you safe
By Philip McNeill, Head of Taxation (Tax Practice and Owner Managed Business Taxes)
1 July 2020
Philip McNeill looks at some recent VAT cases on missing trader fraud and asks if we, our businesses and our clients would pass muster, and what we should do now.
Guilty yet innocent
Any rule which attributes to someone knowledge which they may not in fact have, is likely to be contentious. The Kittel principle (Kittel v Belgium (Case 439/04) [2008] STC 1537) is no exception. Under Kittel, a business unknowingly involved in a fraudulent supply chain can be denied input VAT on purchases where it had the means of knowing that the supply chain was fake. Actual knowledge is not needed.
The position is particularly fraught where someone acting on behalf of the business is aware of the fraud, but hides it from the business owner.
Common sense
Common sense is not enough. Kittel is designed to protect the state from VAT fraud. This principle would be defeated if business owners could sidestep liability by claiming that they didn’t know what was going on.
Indeed, reckless business owners could deliberately aim to keep themselves in the dark, in an attempt to avoid responsibility. They could avoid asking questions about shady or doubtful transactions. But the potential for the unscrupulous to keep themselves deliberately in the dark means that innocence and common sense are insufficient protection for the majority of innocent business owners.
Business owners must attain a new standard. The standard of vigilance – even in the most unassuming of relationships.
Attributed knowledge
In Nicholas and Charlotte Sandham (Nicholas and Charlotte Sandham T/A Premier Metals Leeds [2020] UKUT 0193 (TCC)), the Sandhams used an agent to deal in primary metals. The agent had wide scope to commit the partnership business. But, unknown to the Sandhams, their agent was knowingly a party to fraud.
Given that the agent was acting directly contrary to the Sandhams’ best interests, and outwith any authority from them, could the Sandhams still be liable for their agent’s offence? Even in a criminal case, such attribution would not be automatic, but the Upper Tribunal found that the agent’s knowledge could be attributed to the business.
In a neat parallel, the Tribunal asked how the business could claim input tax on transactions conducted by the agent while distancing themselves from the fraud.
“On one hand, they assert that [the agent] … bound them into the transactions for the purposes of substantiating their claim for input tax credit. However, when it comes to applying the Kittel principle, they seek to distance themselves from [the agent’s] …. knowledge of fraud.”
Crucially, the Tribunal thought that to deny attribution of knowledge from agent to business defeated the entire purpose of Kittel.
“if the knowledge of the agent who entered into the very transactions giving rise to input tax was not attributed to the principal, we accept HMRC’s submission that it might be possible for taxpayers to avoid the consequence of the Kittel rule by entering into transactions through agents while ensuring that they remain ignorant of the full circumstances of those transactions.”
Thus, while acknowledging the innocence of the Sandhams, the wider public good means that taxpayers should not have the option of hiding behind ignorance.
“we recognise that there is no suggestion that the Appellants themselves engaged in such conduct, but we see no reason why the Kittel principle, intended as it is to guard against fraud, should even give taxpayers the option of doing so.
Vigilance in relationships
Just under two million pounds was at stake for the Sandhams, something reinforcing the need for objectivity and vigilance in business relationships.
This point was reinforced in the case of Beigebell (Beigebell Limited [2020] UKUT 0176 (TCC)). Here a friend of 20 years introduced a new business deal. But the deal was associated with VAT fraud.
Hindsight may have given us the advantage of scepticism, but even the First Tier Tribunal (FTT) relieved the company of liability, accepting one of the director’s key submissions of alternative reasonable explanations for entering the transactions.
The Upper Tribunal overturned the decision and remitted it back to FTT. The case is of interest for its consideration of the Kittel tests of “actual knowledge” and “means of knowledge”. It asked the question
“whether, even if Beigebell did not actually know that its transactions were connected with fraud, a reasonable businessperson with ordinary competence in Beigebell’s position would have known”.
It concluded that the FTT had not given sufficient weight to HMRC’s arguments and the decision needed to be remade.
Conclusion
With missing trader fraud the figures are likely to be large. Vigilance on behalf of the state is an aspect of modern business life. While it may not be a welcome addition to the toolkit of business life, and its incidence may seem remote, prudent risk management indicates relationship vigilance (even more than common sense) is needed to keep potential disaster at bay.