Having experienced first-hand HMRC’s attempts to combat serious tax losses, one of the features of tax litigation over the last 15 years has been the prevalence of so-called ‘Kittel’ cases. These are cases in which HMRC seeks to deny repayments of VAT to companies buying goods in circumstances where HMRC has identified a fraud further up the supply chain, often many companies distant. They can involve significant amounts of VAT and form a substantial pillar of HMRC’s compliance strategy.

Clients often ask, “Why should I contest an HMRC assessment – isn’t putting the company into a voluntary liquidation a better option?” In the case of complex appeals, such as Kittel cases, which can be long and drawn-out, the question can be an especially pressing one. As a company director faced with a large VAT bill, the attraction of liquidating the company and starting again may be attractive. Tax litigation can take time, money and will be stressful. In the short term it might seem like an appealing choice to write off your losses and move on with a clean slate. In taxation, however, the choice isn’t that simple.

HMRC has wide-ranging powers to pursue company directors and senior company officers, personally, for VAT debts that were caused by their own dishonesty. More frequently, the same approach to personal penalties is being applied by HMRC to cases of Kittelmeans of knowledge’. This means, as a matter of HMRC policy, that officers of companies that ‘knew or should have known’ of links to fraud in their transaction chains will find themselves running the gauntlet of punitive financial demands, and other measures, having a long-lasting legacy on their lives and careers.

In this article, our tax partner Martin O’Neill will consider the two possible outcomes facing a taxpayer in VAT disputes.


Standard HMRC operating practice requires that when an assessment to tax is raised, or a claim denied, the investigating officers should consider imposing a penalty. In the majority of Kittel cases, penalties are a feature at an early stage, but the legislated time limits for raising penalty assessments are generous and they can become an issue many years after the transactions in dispute were carried out.

Paragraph 1, Schedule 24, Finance Act (2007) (Schedule 24) provides for the imposition of a penalty on a person (company) who gives HMRC one of a specified class of documents, (including VAT returns), which contains an inaccuracy which amounts to, or leads to, an understatement of a liability to tax, a false or inflated statement of a loss, or a false or inflated claim to repayment of tax, where the inaccuracy is ‘careless’ or ‘deliberate’.

Similarly, Section 69C of the Value Added Tax Act (1994) affords HMRC the power to impose penalties on taxpayers whose transactions related to the fraudulent evasion of VAT by another person, and who knew, or should have known, of that connection.

Schedule 24 penalties are calculated with reference to the potential lost VAT, and how the HMRC investigating officer considers them to be:

  • Careless – the failure to take reasonable care;
  • Deliberate but not concealed – a deliberate act to misreport the tax due, but which was not hidden;
  • Deliberate and concealed – a deliberate act of deception was purposely hidden, for example by the production of false invoices or delivery notes.

Penalties are calculated with regard to the above scale at a range of 30%–200% of the amount in dispute depending on the facts of each case. If the taxpayer assists HMRC in their enquiries, providing paperwork and full explanations, the penalties can be reduced.

Section 69C penalties are simply calculated at 30% of the potential lost VAT. This reflects its intended use as a response to circumstances where ‘should have known’ is the highest the HMRC allegation can go.

Schedule 24 (1) and Section 69C penalties are levied on the taxpayer, in most cases a limited company. So, referring back to the title of this article, if the company is liquidated, the penalties become another claim in the liquidation estate. HMRC has secondary preferential creditor status in a liquidation, but nevertheless, there remains a high chance that the penalty will not be paid.

HMRC’s secondary option is found in later paragraphs of the same piece of legislation. Paragraph 19 of Schedule 24 provides:

‘Where a penalty under paragraph 1 is payable by a company for a deliberate inaccuracy which was attributable to an officer of the company, the officer is liable to pay such portion of the penalty (which may be 100%) as HMRC may specify by written notice to the officer.’

The term ‘officer’, for these purposes, includes a director, a shadow director, a manager, or a secretary.

Schedule 24(19) penalties become payable where the company fails to pay the Schedule 24(1) penalty, but the two penalties are generally raised at the same time.

Similarly, Section 69C penalties can be assessed on company officers with reference to powers granted in Section 69D, on much the same manner.


(a)        a company is liable to a penalty under section 69C, and

(b)        the actions of the company which give rise to that liability were attributable to an officer of the company (“the officer”),

 the officer is liable to pay such portion of the penalty (which may be equal to or less than 100%) as HMRC may specify in a notice given to the officer (a “decision notice”)’.

When a company receives a Schedule 24(1), or Section 69C penalty, which was caused by a deliberate inaccuracy by one or more ‘officers’ (a director, a shadow director, a manager, or a secretary), then those officers are also liable to receive a personal penalty in such amounts as the investigating officer decides, potentially up to 100% of the company penalty. Each company officer becomes liable for a penalty individually, but it is not possible for HMRC to raise multiple penalties and potentially recover amounts more than the original 24(1) or 69C penalty. Therefore, a decision to liquidate a company without contesting the underlying VAT appeal can lead to the immediate commencement of proceedings against the former officers of the company to recover penalties. In these proceedings, the personal assets of these officers are at stake.

Dealing with penalties

Penalties, like VAT assessments, can be reviewed internally by HMRC or be the subject of Alternative Disputes Resolution (“ADR”) processes. The most common avenue to resolve such disputes is via an appeal to the Tax Tribunal where an independent specialist Judge hears evidence and legal argument from both parties. Taxpayers usually appeal the imposition of a penalty generally, but it is also possible to appeal the size of the penalty where it is considered that the appropriate mitigation has not been given by the assessing officer.

It is possible to appeal a penalty in circumstances where the underlying VAT decision has not been appealed; however, this is not advisable and could lead to problems and may prevent the ability to contest the penalty. In certain circumstances, a failure to appeal a Kittel decision (or a penalty decision) issued to the company can restrict the arguments that can be raised on a later appeal against a personal penalty. Such a decision depends on the facts of each case, but there is a risk that important aspects of the penalty appeal will not be heard/considered by the Tribunal.

Taxpayers should consider whether the best approach to contesting penalty appeals is at the same time, or after contesting the underlying decisions in a full appeal. This affords more options to the taxpayer, improving the chances of success.

Liquidators and avoidance powers

While HMRC has substantial powers, taxpayers should consider the powers of a liquidator, once engaged.

A liquidator is obliged to investigate the conduct of the former officers of a limited company to ensure they exercised adequate skill and care with proper regard to the interests of the company’s creditors, customers, shareholders, employees and, in some circumstances, the public.

It can also bring claims against individuals in the civil courts to seek the recovery of amounts equivalent to the sums owed by the company, including the VAT man, from any directors who have acted improperly. They could seek to undo transactions which have resulted in the company being unable to pay its VAT and/or to pursue the directors for equivalent sums.

The types of ‘claim’ they may bring, and in relation to which they may seek a recovery from a director, could include transactions at undervalue, the giving of preferences, wrongful and fraudulent trading.

Additionally, a liquidator has the power to recommend that a director be disqualified from holding further directorships for a specified period of time.


Before making any decision not to pursue an appeal against a Kittel decision, and to put the taxpayer company into liquidation, long-term ramifications of such a decision must be considered, as tax enquiries do not necessarily die with the liquidation of the company.

Most companies are penalised because they, subjectively, ‘should have known’ of a fraud committed by someone else (often many companies distant up a supply chain) which is deeply unfair and they will elect to contest it.

Kittel appeals can involve significant sums of VAT, which can have a marked effect on a company’s balance sheet. If insolvency is the only course of action, there remain options available to the taxpayer. Administration affords a company protection from its creditors while it trades through a period of temporary insolvency. This period of trading can, if the administrator considers it in the best interests of the creditors, include the conduct of a tax appeal. Similarly, a liquidator can elect to pursue an appeal on a company’s behalf. In these circumstances every aspect of the VAT and penalty appeals process is contested. The former directors are required to make their own arrangements to fund the actions or come to an arrangement with a litigation funding company, but a failure to do so can have much larger financial ramifications.

In a VAT appeal hearing, HMRC is required to prove each aspect of its case and provide full disclosure of its evidence. In a Kittel appeal, HMRC bears the burden of proving a fraud and its connection to the transactions, and the burden of providing the Tribunal with a list of factors which proves its case on knowledge. While legal representatives can challenge HMRC at every stage, the Tax Tribunal remains the best option to resolve disputes in a taxpayer’s favour, as it is the only forum in which the facts of a case can be decided, and the legal arguments can be made in full.

If you have concerns about a VAT appeal, 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.