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HMRC internal manual

VAT Fraud

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Basic interventions: input tax interventions: input tax incurred by a taxable person who is relying on his right to deduct for fraudulent ends

Introduction

There is a difference between a taxable person who is relying on his right to deduct for fraudulent ends and a taxable person whose transactions are connected with fraudulent evasion of VAT and who either knew or should have known of that fact (the Kittel principle - see VATF50000). The way each is dealt with through civil interventions is therefore also different.

Case law

I/S Fini H (‘Fini H’ - Case C-32/03)

Fini H was a limited partnership that was created with the object of running a restaurant. It leased premises for a 10 year term but the restaurant closed before the expiration of the 10 years. Fini H continued to be a taxable person and reclaim VAT on costs incurred in relation to the lease, even though it made no supplies.

The ECJ was asked, in short, whether Fini H could still be regarded as a taxable person and entitled to deduct input tax. In answering that question the ECJ stated:

  1. The right to deduct VAT on account of the winding-up of the business must therefore be recognised in so far as its application does not give rise to fraud or abuse.

  2. In that regard, the Court has already held that Community law cannot be relied on for abusive or fraudulent ends (see, inter alia, Case C-‘367/96 Kefalas and Others [1998] ECR I-‘2843, paragraph 20, and Case C-‘373/97 Diamantis [2000] ECR I-‘1705, paragraph 33). That would be the case, for example, if Fini H, whilst relying on the right to deduct VAT in respect of the payment of rent and charges relating to the period after the cessation of the restaurant business, continued to use the premises previously used as a restaurant as premises for purely private purposes.

  3. If the tax authorities were to conclude that the right to deduct has been exercised fraudulently or abusively, they would be entitled to demand, with retrospective effect, repayment of the amounts deducted (see, inter alia, Rompleman, paragraph 24; INZO, paragraph 24; and Gabalfrisa, paragraph 46).

  4. It is, in any event, a matter for the national court to refuse to allow the right to deduct where it is established, on the basis of objective evidence, that that right is being relied on for fraudulent or abusive ends.

Axel Kittel & Recolta Recycling SPRL

The above principle was repeated in the ECJ’s judgement in the case of Axel Kittel & Recolta Recycling SPRL (Kittel) (VATF52200) at paragraphs 53 to 55 (see below).

Mobilx Ltd (in administration) and others ([2010] EWCA Civ 517)

These two principles were looked at by Moses LJ in the Court of Appeal judgement in the case of Mobilx Ltd (in administration) and others. He stated:

  1. From § 53-55 in Kittel the Court set out the starting point for its development of the principles relating to cases where the taxable person was himself acting fraudulently:-

“53. By contrast, the objective criteria which form the basis of the concepts of ‘supply of goods effected by a taxable person acting as such’ and ‘economic activity’ are not met where tax is evaded by the taxable person himself (see Case C-255/02 Halifax and Others [2006] ECR I-0000, paragraph 59).

  1. As the Court has already observed, preventing tax evasion, avoidance and abuse is an objective recognised and encouraged by the Sixth Directive (see Joined Cases C-487/01 and C-7/02 Gemeente Leusden and Holin Groep [2004] ECR I-5337, paragraph 76). Community law cannot be relied on for abusive or fraudulent ends (see, inter alia, Case C-367/96 Kefalas and Others [1998] ECR I-2843, paragraph 20; Case C-373/97 Diamantis [2000] ECR I-1705, paragraph 33; and Case C-32/03 Fini H [2005] ECR I-1599, paragraph 32).

  2. Where the tax authorities find that the right to deduct has been exercised fraudulently, they are permitted to claim repayment of the deducted sums retroactively (see, inter alia, Case 268/83 Rompelman [1985] ECR 655, paragraph 24; Case C-110/94 INZO [1996] ECR I-857, paragraph 24; and Gabalfrisa, paragraph 46). It is a matter for the national court to refuse to allow the right to deduct where it is established, on the basis of objective evidence, that that right is being relied on for fraudulent ends (see Fini H, paragraph 34).”

  3. In Kittel after § 55 the Court developed its established principles in relation to fraudulent evasion. It extended the principle, that the objective criteria are not met where tax is evaded, beyond evasion by the taxable person himself to the position of those who knew or should have known that by their purchase they were taking part in a transaction connected with fraudulent evasion of VAT:-

“56. In the same way, a taxable person who knew or should have known that, by his purchase, he was taking part in a transaction connected with fraudulent evasion of VAT must, for the purposes of the Sixth Directive, be regarded as a participant in that fraud, irrespective of whether or not he profited by the resale of the goods.

  1. That is because in such a situation the taxable person aids the perpetrators of the fraud and becomes their accomplice.

  2. In addition, such an interpretation, by making it more difficult to carry out fraudulent transactions, is apt to prevent them.

  3. Therefore, it is for the referring court to refuse entitlement to the right to deduct where it is ascertained, having regard to objective factors, that the taxable person knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, and to do so even where the transaction in question meets the objective criteria which form the basis of the concepts of ‘supply of goods effected by a taxable person acting as such’ and ‘economic activity’. [emphasis added]”

The words I have emphasised “in the same way” and “therefore” link those paragraphs to the earlier paragraphs between 53-55. They demonstrate the basis for the development of the Court’s approach. It extended the category of participants who fall outwith the objective criteria to those who knew or should have known of the connection between their purchase and fraudulent evasion. Kittel did represent a development of the law because it enlarged the category of participants to those who themselves had no intention of committing fraud but who, by virtue of the fact that they knew or should have known that the transaction was connected with fraud, were to be treated as participants. Once such traders were treated as participants their transactions did not meet the objective criteria determining the scope of the right to deduct.

Application of the I/S Fini principle

If you wish to refuse a taxable person’s entitlement to the right to deduct input tax because it has been established that the right to deduct is being relied on for fraudulent ends you must contact the VAT Fraud Team prior to taking any action.