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HMRC internal manual

VAT Fraud

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The Kittel principle intervention: Kittel in more detail: What is meant by ‘knew or should have known’: Extent of what a taxable person 'should have known'

The Court of Appeal in the joined cases of Mobilx Ltd (in administration) and others ([2010] EWCA Civ 517), considered the question of exactly what the taxable person ‘should have known’. The High Court, in its judgment in the case of Blue Sphere Global Ltd ([2009] EWHC 1150 (Ch)), had concluded that the right to deduct could only be denied where the taxable person knew or should have known that the transaction was connected with fraudulent evasion of VAT. HMRC argued that a taxable person’s right to deduct could be denied if he knew or should have known that it was more likely than not that his purchase was connected with fraudulent evasion of VAT. The court rejected both of those arguments and stated:

  1. The test in Kittel is simple and should not be over-refined. It embraces not only those who know of the connection but those who “should have known”. Thus it includes those who should have known from the circumstances which surround their transactions that they were connected to fraudulent evasion. If a trader should have known that the only reasonable explanation for the transaction in which he was involved was that it was connected with fraud and if it turns out that the transaction was connected with fraudulent evasion of VAT then he should have known of that fact. He may properly be regarded as a participant for the reasons explained in Kittel.

  2. The true principle to be derived from Kittel does not extend to circumstances in which a taxable person should have known that by his purchase it was more likely than not that his transaction was connected with fraudulent evasion. But a trader may be regarded as a participant where he 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 such fraudulent evasion.

VATF53425 explains what is meant by ‘the only reasonable explanation’ and how this is demonstrated.

When looking at whether a taxable person ‘should have known’ that his transactions were connected with fraudulent evasion of VAT, the taxable person’s general awareness (VATF53430), contrived features of the transaction chain (VATF60000), and the way the taxable person ignored negative indicators from its due diligence and risk assessment (VATF70000), will be important.

A taxable person should also have made a judgement based on his risk assessment that if the transaction appeared to be ‘too good to be true’ then it probably was. In such a case he should have either refrained from entering into the transaction or undertaken a more thorough risk assessment. If he ignored the risks and continued then, as the Court says, ‘he 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 such fraudulent evasion’.