VAT & Kittel Principle
Where HMRC denies input VAT on the basis that a business knew or should have known its transactions were connected to fraud, the outcome is usually presented as binary - either the denial stands or it does not. A recent First-tier Tribunal decision is a useful illustration of how a more nuanced, fact-specific analysis can produce a partial result, with significant consequences for the quantum of tax and penalties in dispute.
In Sweetmotion Ltd v HMRC, HMRC denied input VAT on purchases of fast-moving consumer goods, contending that the company's director, Mr Jenkins, knew or should have known the transactions were connected to Missing Trader fraud. The Tribunal partially allowed the appeal, drawing a clear dividing line at a specific date.
Under the Kittel principle, HMRC must establish three things: that there was a fraudulent evasion of VAT, that the taxpayer's transactions were connected to that fraud, and that the taxpayer knew or should have known of the connection. The third limb was the central issue here. The Tribunal accepted that Mr Jenkins had no actual knowledge of the fraud, finding him to be a person of high integrity who was naive rather than complicit. However, naivety has its limits as a defence.
The critical date was 19 January 2021, the day after HMRC met with Mr Jenkins and corresponded with him directly about the hallmarks of VAT fraud in his trade sector. Before that date, the Tribunal was satisfied that his failure to identify the connection to fraud was consistent with his character and his limited understanding of the risks. After that date, a reasonable director armed with that information should have known. Input VAT was denied only for transactions falling after that point, and the associated penalties were both reduced in scope and mitigated further, reflecting Mr Jenkins' lack of intent and the company's cooperation with HMRC's investigation.
The Tribunal also noted that HMRC's delay in intervening had prolonged the period of exposure. Had HMRC acted sooner, the line would have been drawn earlier. That observation did not alter the outcome, but it is a relevant consideration in cases where HMRC holds information about fraud risks in a particular supply chain and is slow to share it.
For advisers, the practical message is that a formal intervention from HMRC - whether a meeting, a letter, or a visit - materially raises the standard of what a business is expected to know. Once that threshold is crossed, continued trading in the same supply chain without heightened due diligence will be difficult to defend.
