This article considers the practice of Her Majesty’s revenue and Customs (“HMRC”) refusing to deduct a company’s Input Tax or to de-register the company’s VAT number owing to a suspicion that the company in question is involved in fraud, or is a party to suspicious transactions. The result of such an enquiry inevitably causes financial and reputational damage to the company concerned.
Many of the companies affected will often not appreciate the implications of receiving an initial request from HMRC for further information as a prelude to the issuing of a notice. The impact experienced by an enquiry of this type can be cured or mitigated by adopting a proactive approach to HMRC which can, if handled properly, prevent or minimise the impact from of an investigation of this type.
What should a company do when faced with a VAT enquiry by HMRC?
It should always quickly respond and enter into dialogue with HMRC to see if the matter can be resolved with further information being provided by the company to HMRC. Advice should always be sought on how to respond and to consider carefully the evidence that should be presented to HMRC to rebut any allegation or suspicion of impropriety or fraud that is alleged against the company.
If the investigation continues, HMRC, in seeking to justify their actions, will usually refer within their correspondence to the case of Kittel v Belgium  ECR1 – 6161 in stating that they are satisfied that the company in question knew, or should have known, that the transactions in issue were connected with the fraudulent evasion of VAT. This is often alleged without any criminal investigation or enquiry and is based on HMRC’s opinion that the transactions under consideration can be “traced back to fraudulent tax losses”. An honest company is sometimes at a loss as to why HMRC are making such allegations and are shocked to find that substantial amounts of money are involved and that HMRC then move directly to deregistering the company for VAT.
If this event occurs, the company can challenge the decision by formally requesting a Review which should be submitted within 30 days of being notified that the decision has been taken to de-register the Company’s VAT registration. HMRC will then have 45 days from receipt of receiving the company’s representations to consider the Review. This should be carried out by an officer not previously involved with the company’s case. It should be noted that Lodging a Review does not affect the right to Appeal the HMRC decision generally.
Matters that should be included within any Review are as follows.
Notice 726 and Fraudulent Tax Losses
It will be necessary to check whether HMRC Notice 726 concerning joint and several liability for unpaid VAT actually applies to your business and crucially whether there is actually evidence of a “Fraudulent” Tax Loss.
The decision in the case of Ronald Hull Junior Ltd v Revenue & Customs (Recovery of input VAT in the scrap metal trade)  UKFTT 76 (TC) First-tier Tribunal (Tax) makes it clear that any denial of VAT input tax by HMRC requires:-
– a tax loss
– that the tax loss is as a result of fraudulent evasion of VAT
– a connection between the fraudulent evasion of VAT and the transactions on which input tax is denied.
– where there is such a connection, a situation where the trader (having regard to objective factors) knew or should have known that its transactions were connected with the fraudulent evasion of VAT .
Evidence of Fraud
HMRC should be requested to produce objective evidence to support the assertion that tax losses for each of the transactions arose as a result of fraud rather, for example, as a result of a conventional bad debt or a failed business. Ronald Hull Junior Ltd stipulates that even if HMRC can prove the tax losses occurred as a result of fraud, HMRC must then go on to prove a connection between that fraud and the company’s transactions and that it knew, or should have known, that the transactions were connected with fraud.
The need for tangible evidence is essential in any case brought by HMRC against a company. This was stipulated in the case of Moblix Ltd v HMRC  EWCA Civ 517. The Court confirmed that it was for HMRC to prove that a person was or should have known that he was participating in a transaction connected with VAT fraud. The Court of Appeal (LJ Moses) stated;
“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“.
HMRC often allege that the company did not carry out appropriate due diligence for the customer (or customers) in question from whom the transactions flowed. However, the Judgement in Moblix emphasised that;
“the ultimate question is not whether the trader exercised due diligence but rather whether 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“.
So a subjective view reached as to the extent, or lack of, due diligence should not be a determinative factor for HMRC when making its decision. It should be also be noted that any decision based on the application of this criteria is also contrary to its own guidance; HMRC Internal Manual VATF8000 VAT Fraud, 10th April 2016/ Updated 13.1.20 states:
“Where Officers identify evidence of ineffective due diligence this should be documented as an absence of alternative evidence of the taxable supplies rather than as evidence.…”
The above are only some of the factors to consider when challenging HMRC decisions. Shearman Bowen has extensive experience in investigations conducted by HMRC having acted for individuals, directors and companies faced with such enquiries. For more information on the above and other services we offer please contact senior partner Mark Bowen.