My client is a restaurant which had a major refurbishment of their premises.  They employed a builder to carry out the work.  The job was completed and invoiced with VAT.  The restaurant then claimed the input tax on its next available VAT return and submitted to HMRC.  Given the size of the repayment due to the building work HMRC checked the return submitted.  Enquiries highlighted that the builder who carried out the work was now a missing trader and they disallowed the VAT claimed on the invoice.  They did this on the basis the restaurant knew, or should have known, the transaction they entered into was involved with the fraudulent evasion of VAT – the Kittel Principle. Are they allowed to do this? 

The Kittel Principle has been used by HMRC over several years particularly in combatting Missing Trader Carousel Fraud.  Following a number of queries, it appears HMRC are using it across a much wider range of scenarios to deny input tax claims.

The VAT Act 1994 section 25(2) gives the entitlement to credit for input tax and 29(2) of the VAT General Regulations 1995 details the evidence required for deducting input tax. In most cases this will be a proper tax invoice from the supplier detailing the supplies made and the relevant value and applicable VAT amounts.

The Kittel principle was established by the European Court of Judgement in the cases of Axel Kittel and Recolta Recycling SPRL.  Essentially both cases involved recovery of VAT where the participants were involved in carousel fraud and the ECJ in summary ruled that where the supply is to a taxable person who knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, it is for the national court to refuse that taxable person entitlement to the right to deduct.

HMRC should apply the following principles in establishing whether to apply Kittel – was there fraudulent evasion of VAT? – in this scenario did the builder declare and pay the output tax due on the transaction. Was the transaction ‘connected with’ that fraudulent evasion of VAT? – in this scenario the chain should be very short and presumably the builder is the missing trader who failed to pay the vat due to HMRC.  Most importantly 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’?

This can be the most difficult and contentious area and will depend on several factors.  For instance, were the restaurant and the builder connected ether commercially or socially.  How did the restaurant hire and contact the builder, was there a quote, building plans and regulations and planning permission?  The list is endless but the more detail relating to the transaction the more likely there was a legitimate supply for VAT purposes. HMRC will also look at the knowledge of the person and the pricing around the work being carried out.  Was the work carried out consistent with the value charged or was it over-inflated? Conversely, was the costing of the work only viable because the VAT was never going to be paid over to HMRC.  HMRC will often use the phrase “was the pricing of the transaction too good to be true?”.  If it was then the taxable person should have either refrained from entering into the transaction or undertaken a more thorough risk assessment. If they ignored the risks and continued, they should have known that the only reasonable explanation for the circumstances in which his purchase took place was that it was a transaction connected with fraudulent evasion.

These cases can be complex and contentious and if HMRC decide to deny input tax it is advisable to seek specialist advice.

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VAT Adviser

David has worked in a variety of compliance roles for HMRC for over 30 years prior to joining Croner Taxwise.  He began his career as a VAT Compliance Officer before moving as a Computer Audit Officer to Large Business where he was responsible for VAT audits at some of the largest companies in the UK.  Since then, he has worked as VAT Consultant specialising in Alcohol and Missing Trader fraud.

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