HMRC seeks views on new penalty for participants in VAT fraud

Out-Law News | 04 Oct 2016 | 5:02 pm | 3 min. read

A new penalty proposed by HM Revenue and Customs (HMRC) could capture businesses and company officers that "should have known" about the presence of fraud somewhere in the supply chain, as well as those who actually knew about the fraud.

HMRC has set out two potential options for the penalty, which could be as much as 50% of the VAT that would otherwise have been due.

"Organised VAT fraud presents a significant risk to the public revenue," HMRC said in its consultation. "It commonly involves supply chains which seek to distance those behind the fraudulent evasion of VAT from the parties and supplies in the chain."

If the government decides to introduce the new penalty, HMRC would be able to issue it at the same time as it takes action to address the primary fraud issue.

Under current rules, HMRC can only issue penalties against the rest of the supply chain once the primary VAT case is finalised, including litigation. This approach, causes two problems, according to HMRC: firstly, the potential for a second round of litigation, this time against the penalty; and secondly, the risk that by the time the penalty is issued any money owed will have already been dispersed by those involved in the fraud.

The new penalty would be based around the current knowledge principle, or 'Kittel principle', which prevents businesses from reclaiming VAT as input tax if they knew, or should have known, that their transactions were connected with VAT fraud. However, HMRC intends to do away with the distinction between "knew" and "should have known" for the purposes of the new penalty.

HMRC has proposed two broad design options for the new penalty, although it has asked for views about other options as part of the consultation exercise. Option A is a fixed rate, 30% penalty which would apply in all cases where the knowledge principle is applied; while option B would allow for early payment of a 25% penalty in cases where the knowledge principle is applied. This penalty would increase to 50% if HMRC's finding was appealed and the court later rules that there was actual knowledge of the fraud.

Option A has the benefit of aligning the test for the penalty with the knowledge principle, removing the need for separate tribunal hearings as is presently the case. This would save time and costs for businesses and the tribunal service, and could save HMRC around £1 million a year, according to the consultation. Option B would have many of the same advantages, with the additional advantage of discouraging frivolous appeals by those involved in VAT fraud.

In each case, the new penalty would apply to both the company itself, and to company officers such as directors and company secretaries. Penalties could be issued against individuals whether they knew or ought to have known that the transactions were connected with VAT fraud. Currently, individuals can only be penalised where there is evidence of deliberate behaviour.

HMRC said that the new penalty would "be more effective" if it included company officers, as well as the companies themselves.

"Without this, the individuals responsible for the business' participation in VAT fraud can simply walk away from company liabilities with no personal sanction against them," it said in its consultation.

However, VAT and indirect taxes expert Stuart Walsh of Pinsent Masons, the law firm behind, said that this particular proposal was "potentially concerning".

"Logically, there is likely to be little sympathy for directors incurring personal liability in circumstances where they allow their company to enter into transactions in full knowledge that they are participating in a VAT fraud, given that it essentially demonstrates dishonest behaviour," he said.

"However, the proposal suggests extending, in certain circumstances, the same level of personal liability to company officers who 'should have known' that their company's transactions were connected to fraud - conduct akin to careless behaviour. Personal liability in these circumstances appears excessive, and it is very difficult to rationally justify a 'one size fits all' approach to two very different types of behaviour," he said.

HMRC is not proposing any penalty reductions in exchange for disclosure of information, although it is seeking views on whether to include this in the design in a separate part of the consultation. It is also seeking views on whether to 'name and shame' those who participate in VAT fraud. The consultation closes on 11 November.