Out-Law News 2 min. read

UK government to proceed with 'one size fits all' penalty in VAT fraud cases


The UK government's decision to proceed with a flat rate penalty of 30% in all VAT fraud cases against the views of businesses is a disappointing one, an expert has said.

The form of the new penalty "means that an unwitting business targeted by fraudsters, who 'should have known' of the connection to fraud, is treated identically to those businesses that knew of the connection and deliberately participated", according to tax expert Clara Boyd of Pinsent Masons, the law firm behind Out-Law.com.

"Parity of penalty for very different behaviours does not seem fair," she said.

"By rejecting calls to allow the penalty to be capable of mitigation, HM Revenue and Customs (HMRC) offers absolutely no incentive to businesses to assist HMRC with its investigation. HMRC states that any reduction would reduce the effectiveness of the penalty, but this seems short-sighted and perhaps speaks more to the inherent weakness of the penalty's design," she said.

Legislation introducing the new penalty will be included in the 2017 Finance Bill and the draft clauses have been published for comment. It will come into force on the date that that legislation receives Royal Assent.

The new penalty is based on the 'knowledge 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. This principle is also known as the 'Kittel principle', after the 2006 case in which the Court of Justice of the European Union (CJEU) established this point.

The current penalty regime distinguishes between deliberate and 'careless' frauds, and so requires HMRC to wait to assess the penalty until any underlying litigation in respect of the entitlement to the recovery of input tax is determined. This can than result in a second round of litigation against the penalty. To address this problem, HMRC intends to do away with the distinction between 'known' and 'should have known' and issue a single 30% fixed rate penalty in all cases where the knowledge principle is engaged.

HMRC said that there was a "strong case" for having the new penalty aligned with the knowledge principle. This would help to "streamline cases and strengthen HMRC's ability to tackle serious VAT fraud", as well as providing significant deterrent benefits, according to a response to its consultation on the proposals.

The new penalty will apply to both the company itself, and to company officers such as directors and company secretaries. Currently, individuals can only be penalised where there is evidence of deliberate behaviour. However, the new penalty may be issued against an individual who either knew, or ought to have known, that the transactions were connected with VAT fraud.

In its consultation response, HMRC sought to "reassure respondents" that individual company officers would only face penalties in cases where the individual "'knew or should have known' of the fraud". The legislation "will specify that the penalty will apply to the business and will only be transferable to a company officer when they knew or should have known of the fraud", HMRC said.

However, tax expert Stuart Walsh of Pinsent Masons said that personal liability for company officers who "should have known, but ultimately did not know, of the connection to fraud", was "aggressive".

"The purported safeguards HMRC offers concerning the exercise of its discretion may be of little comfort to honest directors who find their businesses unwittingly participating in a supply chain fraud," he said.

HMRC also intends to proceed with plans to 'name and shame' VAT fraud participants, albeit in a more limited form than originally proposed. It will limit naming to cases where the VAT at issue is over £50,000 and there is "persistent offending or clear evidence of wrong-doing", in order to address concerns raised during the consultation process about naming those involved in 'should have known' cases.

The legislation will make it clear that naming participants is only optional, and any use of the naming provision will be "subject to a strict governance process within HMRC", according to the consultation response.

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