The Kittel Principle | The Importance of Due Diligence
Under the Kittel Principle, a business involved in transactions connected to fraud can be denied the right to reclaim input tax on those transactions. This can have catastrophic consequences, making it essential for business owners to be constantly vigilant to the potential presence of fraud in their supply chain.
In several previous articles posted to this website, we have explained in considerable detail various aspects of the Kittel Principle including its key elements, the obligations placed on company directors and officers and the nature of ‘suspicious or dubious’ activity’ to look out for.
We have previously emphasised the need for businesses to exercise stringent due diligence measures to ensure compliance with the VAT regulations, accurately pay the VAT due on all applicable transactions, and avoid unintentional involvement in any fraudulent activity.
However, as HMRC intensifies efforts to recover VAT and to target certain trade sectors, such as payroll companies, where it identifies increasing patterns of fraud, the issuance of Kittel Notices denying businesses the recovery of input tax has increased enormously.
Given the clear intent of Government to harvest as much tax revenue as possible, it remains essential that companies and their officers remain alert to the need to exercise due diligence and the potential consequences of failure to do so.
In practice, a major problem to a business lies in the fact that by the time HMRC serves a Kittel Notice, the input tax will already have been paid to that business. The Kittel Notice will require repayment of those funds, which may well be substantial, and if the resources are not available to pay HMRC, the business will clearly face substantial difficulties.
Accordingly, it is essential for businesses to ensure compliance with VAT Regulations and recognise that failure to do so may result in the service of a Kittel Notice.
Mohammed Ahmed of KANGS highlights the nature of due diligence and some of the potential consequences arising from the receipt of a Kittel Notice.
Application by HMRC of the Kittel Principle
HMRC scrutinises transactions of a business, including its supply chains, to ensure that there is no involvement in fraudulent activity. When conducting its investigations HMRC may be alerted to the possible existence of fraud by a number of markers such as:
- the contrived nature of the trading to produce artificial profit margins,
- a series of new companies in a trading chain, only engaged in the activities of that chain,
- lack of insurance of any sort including transportation of the goods,
- absence of any form of marketing to attract new customers,
- third party or offshore payments,
- failure to conduct due diligence.
Where any such markers are identified HMRC will issue a Kittel Notice and will commence investigations by:
- requesting detailed documentation as it requires,
- meeting with company officers,
- conducting audits.
Due Diligence
The Kittel Principle renders a business accountable for both its own actions and involvement in fraudulent supply chains. It will be denied claims for input tax if proven that the existence of fraud was known or should have been known.
This requirement demands that the business itself, and all of those involved, can be seen to have in place and conduct sufficient due diligence procedures to identify any signs of potential fraud. The process of due diligence is on-going and requires amendment and upgrading whenever circumstances require.
Simply turning ‘a blind eye’ to a possibility of fraud will be regarded as tantamount to knowledge of fraud.
Due diligence procedures vary enormously, according to the nature and size of the trading activity, but should encompass some minimum steps. HMRC are unwilling to provide a definitive list of acceptable due diligence actions but at KANGS we are able to assist businesses with such matters.
Potential Consequences of a Kittel Notice
Denial of Input Tax
- The starting point for HMRC would be to deny a taxable trader the right to claim input tax.
- HMRC will review past claims as well as the current period with the intention to recover the claimed amounts from the company leading to a VAT Assessment being issued.
Penalty Notices
- In the likely event of an issue of a VAT Assessment, businesses can find themselves in receipt of Penalty Notices for the portion of unpaid VAT.
- HMRC may charge daily interest on the outstanding amounts.
Company Officers
- Company officers may be made personally liable for VAT. HMRC is required to establish that a tax loss has occurred and that it was the result of deliberate wrongdoing or serious neglect.
- HMRC can issue a Personal Liability Notice which will transfer all or part of the debt to the directors and other officers of the company for payment.
- Director Disqualification Orders. Proceedings may be issued seeking the disqualification of any director from holding any official post for a period up to fifteen years.
- Criminal charges. In the event of a successful prosecution being conducted, a lengthy prison sentence may be imposed according to the severity and impact of the crime.
Ongoing Audits & Compliance Checks by HMRC
- HMRC may become more involved in the functioning of the business by way of introducing additional audits.
- Ongoing audits and compliance checks conducted by HMRC can cause disruption to the day-to-day functioning of the company and further cause a pressured environment in the company surroundings.
Damage to the Reputation of the business
- Any business subjected to a VAT fraud enquiry will potentially suffer damage to its reputation and damage relationships with suppliers and customers.
- Additionally, relationships with financial institutions may well be disrupted.
VAT Deregistration
- HMRC can exercise its power to cancel a VAT registration if the principal aim of the registration was to facilitate fraud.
- In many cases, deregistration would probably result in the business ceasing to trade.
How Can We Help?
The receipt of a Kittel Notice requires immediate detailed attention by legal experts to help mitigate potential consequences that could significantly impact the company and its officers.
Ideally, every business should exercise a comprehensive due diligence system to ensure that, in the unfortunate event that it innocently becomes involved in a fraudulent supply chain, its measures satisfy the criteria clearly required by the European Court of Justice (ECJ) set out in the statement below.
‘… traders who take every precaution which could reasonably be required of them to ensure that their transactions are not connected with fraud, be it the fraudulent evasion of VAT or other fraud, must be able to rely on the legality of those transactions without the risk of losing their right to deduct the input VAT.’
The team at KANGS offers assistance by providing skilled representation and promptly opening communication with HMRC to address the Kittel Notice. We will work to uncover the specific circumstances and evidence HMRC is using as the basis for their actions, allowing us to assess the position and advise the business of the most effective strategies to resolve the matter efficiently.
If you have been contacted by HMRC please do not hesitate to get in touch with the Team at KANGS using the details below, they will be pleased to speak to you:
Tel: 0333 370 4333
Email: info@kangssolicitors.co.uk
We provide initial no obligation discussion at our three offices in London, Birmingham, and Manchester. Alternatively, discussions can be held through live conferencing or telephone.
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