INPUT TAX - 29.01.2024

When will HMRC disallow input tax with the Kittel principle?

What is the Kittel principle?

Your business can claim input tax on expenses that relate to your taxable supplies, as long as you meet the usual conditions for claiming input tax, i.e. you have been charged VAT by a registered supplier and hold a tax invoice to support your claim.

The “Kittel principle” was established following a 2006 judgment of the European Court of Justice (ECJ) in the case of Axel Kittle & Recolta Recycling SPRL . It gives the tax authorities the power to disallow input tax if they can show that: “the supply is to a taxable person who knew or should have known that, by his purchase, he was participating in a transaction connected with the fraudulent evasion of VAT.”

Example. Donato Widgets has been approached by a new supplier with the offer of buying 100,000 widgets at 50p per unit plus VAT when the market rate is usually 65p. Donato agrees the deal because the supplier says they know a potential customer who will buy the widgets for 75p plus VAT, i.e. an easy profit for Donato. It is likely that the deal is fraudulent and Donato should be cautious.

Trap. Fraudulent suppliers who charge 20% VAT on their invoices and then disappear without paying it to HMRC usually have a brief trading history; they have no physical premises where they operate their business; the directors are often inexperienced and cannot demonstrate a track record in their industry. You should avoid such deals in all cases!

How does HMRC apply Kittel?

Officers must consider what are known as the three limbs of a Kittel situation:

1. Was there any fraudulent evasion of VAT, i.e. a supplier charging 20% VAT and then failing to declare and pay output tax on a return?
2. Was the transaction being reviewed by HMRC - the purchase and sale of 100,000 widgets in the above example - connected with VAT fraud?
3. Did the buyer - our subscriber - know or should have known that it was connected with VAT fraud?

Tip. Our subscriber must show HMRC that all deals with this supplier were operated on normal commercial terms, assuming this was the case, and there was no indication of any VAT fraud.

Should have known?

If your business was offered the chance to buy a car worth £20,000 for, say, £5,000, you would be naturally suspicious and steer clear of the deal. If you turned a blind eye and bought the car, and it was a stolen vehicle, you would not be able to plead innocence. The same principle applies with input tax and the Kittel principle and the phrase “should have known” that it was connected to VAT fraud.

HMRC should have asked our subscriber about the due diligence checks they applied before dealing with this supplier and if a risk assessment was carried out for the deals in question. HMRC’s guidance comments that a business owner “should also have made a judgment based on his risk assessment that if the transaction appeared to be ‘too good to be true’ then it probably was. ”

Tip. Our subscriber should appeal against the assessment if they are satisfied they have acted with diligence and commercial awareness for all deals with the disputed supplier.