Taking a case to the Tax Tribunal is a big undertaking for most companies. Contesting a contentious decision by HMRC is not something that companies want to do because it’s expensive, time-consuming and stressful. In the current environment, however, HMRC is raising more contentious decisions and relying on taxpayers’ inability (either through lack of funds or lack of evidence) to take cases to court as part of its efforts to reduce the tax gap.

The Kittel criteria

The Kittel criteria, where VAT claims are denied on the basis that a company ‘should have known’ about a fraud committed by others in the supply chain, have become a staple of HMRC’s enforcement strategy. Kittel decisions can involve very large sums of money, and companies trading on so-called ‘grey’ or ‘secondary’ markets, for example those who resell consumer electronics, remain high on the HMRC’s hit list. Added to that more recently are companies supplying labour to the construction industry, but any market in which a supply chain exists is potentially at risk. To mitigate the risk of being on the receiving end of an HMRC investigation, there are some actions trading companies can take to make sure they don’t end up receiving exorbitant tax bills that they can’t defend.

How can you increase your chance of success?

  1. Get advice early – The best dispute is one that doesn’t go to court. Being fully aware of the risks means you are more likely to see any warning signs and sidestep a suspect transaction. Additionally, no system guarantees 100% insulation against tax loss risk, but HMRC is less likely to pursue you if your company is well run, you have taken advice from a professional and you can show you have taken effective steps to manage tax loss risk. Getting your trading procedures professionally reviewed may incur a cost, but it is a lot quicker and cheaper than a tax dispute.
  2. Don’t represent yourself – Before any dispute, HMRC will conduct its investigation. This will involve having meetings with you and an analysis of your books and records. You won’t be told you need to have advisers present, and commonly HMRC try to keep the meetings relaxed. It may not feel like it, but the HMRC officers are conducting a serious investigation and there are rules that they must follow. You’ll be encouraged to speak freely but everything you say will be noted, and potentially quoted out of context. A specialist advisor should be present to make sure everything is done properly. Too many cases are lost through taxpayers making mistakes in early meetings with HMRC, making unnecessary concessions that can adversely affect the chances of success at a hearing.
  3. Keep notes of everything – Business is frequently based on maintaining personal relationships with a range of key suppliers and customers, and about utilising your personal skills to get the best prices and stock. HMRC and the courts typically don’t think like that. HMRC appears to trust systems and procedures that can be audited and distrusts personal approaches, so traders need to be able to evidence the steps they took. Don’t delete emails or WhatsApp messages, always record or keep notes of calls and meetings and keep these filed securely. These are an important tool that will enable your advisors to prove aspects of your case that would otherwise be lost.
  4. Be careful what you write – Be businesslike. We all use WhatsApp and other messaging platforms to speak with our trading partners, some of whom we know well. Think forward, however. If a transaction is disputed in the future, you will want to rely on these conversations as evidence, so don’t include personal opinions, language or anything that you wouldn’t want to have read in public 5–10 years in the future.
  5. Know who you are dealing with – We are all familiar with the need to conduct due diligence checks on trading partners and most traders do it. It is important that the information on these documents is analysed and secondary enquiries made if necessary.
  6. Review, review, review – It pays dividends not only to get your trading procedures approved at the start, but as part of an ongoing process. We advise regular reviews to monitor internal management and to have your completed trades analysed to make sure that you aren’t missing anything and that you (or your staff) are doing what is required to minimise tax loss risk. Consider how often you re-check the credentials of trading partners.

The Kittel criteria is a risk to all companies trading in supply chains. Realistically, it is impossible to know what route a consignment of goods had followed before it reached you. Nevertheless, the Kittel criteria means that you can end up with a large tax bill if a company of which you have no knowledge did not pay its VAT (either in the UK or elsewhere), or if a consignment of used mobile phones has been bought ‘under margin’ when it shouldn’t have been. The application of the Kittel principle in the UK means that the perpetrators of the frauds will almost certainly escape prosecution, and the established companies will end up having to pay the bill or fight their cases in court.

If you have any questions about this article or have another issue that you want to discuss, please contact Martin O’Neill.

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This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.