Successfully defending allegations of fraud raised by HMRC

We acted for a company that was supplied with professional services by another company. Both companies were under common control and shared the same director.

The company that received the professional services made the standard claim for repayment of VAT input tax from the two VAT invoices raised in respect of the services supplied. However, the supplying company did not pay the output VAT. The supplying company was trying to manage cash flow and was waiting for HMRC to make the VAT repayment on the input tax and use that to fund the output VAT.

Everything was as expected in the normal course of how many businesses manage VAT inputs and outputs between connected companies. This was until HMRC refused to make the VAT repayment claim made by the purchaser for input tax on the grounds that the supplier had allegedly acted fraudulently. As a result, HMRC not only refused the repayment of VAT but also applied penalties on incorrect VAT returns.

Gannons were engaged to represent the company seeking to claim back its VAT.  We were successful.  The Tax Tribunal held that HMRC had failed to plead its case correctly and the Tax Tribunal struck out the fraud allegations and the penalty charge. The Tax Tribunal found HMRC to be unsuccessful in seeking to establish that because one connected company had failed to pay its VAT output tax, the other company should be denied its claim for input tax. We were very pleased with the outcome achieved.

VAT allegations raised by HMRC

HMRC’s basis for its case against our client was that either:

• the right to deduct input tax was being relied upon for fraudulent evasive ends (the Fini principle); or
• the supply of services were connected with the fraudulent evasion of VAT and that the director of the company knew or ought to have known about it (the Kittel principle).

VAT penalty

Under the VAT legislation, a person (in VAT language that means the person who is responsible for paying VAT and that could be the company or partnership (as appropriate) or the individual if a sole trader) is liable to an automatic penalty of 30% of the VAT assessed if certain conditions are satisfied.

The conditions are:

• The person being assessed to the penalty entered into a transaction involving the VATable supply of goods or services and
• that the transaction was connected with the fraudulent evasion of VAT by another person; and
• that the person being assessed to the VAT penalty knew or should have known that the transaction was connected with the fraudulent evasion of VAT by another person; and
• that HMRC have issued a valid denial decision preventing the person being assessed to the penalty from recovering VAT.

As was shown in the decision reached by the Tax Tribunal denial decisions issued by HMRC are not always valid.  The Tax Tribunal does have power to quash penalties.

Criminal sanctions for VAT fraud

In addition to VAT assessments, where a case meets the requisite criteria, HMRC can bring criminal charges.

Allegations of fraud or dishonesty, as in this case, are serious. They carry harsh penalties including the possibility of being convicted of a criminal offence. As such, any allegation of fraud or dishonesty must be specifically pleaded by HMRC and be proved beyond all reasonable doubt.

The burden of proof is on HMRC to properly plead the primary facts upon which they intend to rely upon to show that the other party was acting fraudulently or dishonestly. The court and the accused party should not have to dig behind the pleadings in order to detect what the HMRC are alleging.

How our client defended the claim

We were able to show that HMRC had no evidence of fraud as no fraud had actually crystallised. Relying on using the VAT repayment due to one company to pay the VAT owed by another company was held not fraudulent.

The judge did allow HMRC to amend their case to deal with the grounds for recovery of VAT from the supplier more accurately BUT took the opportunity to strike out all the allegations of fraud. The judge found no actual or constructive knowledge of the fraud. The 30% penalty was also struck out.

What to do if you face a VAT issue with HMRC

A VAT inspection can happen randomly or be triggered by tax repayment claims, failure to take reasonable care, non-payment and risk assessments by HMRC. The earlier you take advice the better as there are traps which you may be able to avoid.  A good knowledge of what HMRC can and cannot do and how the burden of proof with criminal allegations works is required.

Our expert team with technical knowledge can help. Please call on 0207 438 1060