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By Contractor Weekly 

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HMRC consults on penalties for VAT fraud

As part of measures to crack down on VAT fraud HMRC are proposing a new penalty which could be collected from company officials. This increasingly favoured method of punishment is suggested in HMRC’s recent consultation titled, ‘Penalty for participating in VAT fraud’.


The discussion document, which closes on 11th November, discusses whether to introduce a new penalty for participating in VAT fraud and considers a range of options for those who knew or should have known that their transactions were connected with fraud.

VAT fraud represents a significant risk to the public purse and commonly involves supply chains which seek to distance those behind the fraudulent evasion of VAT from the parties and supplies in the chain. The actual proceeds of the fraud are typically realised via a VAT repayment further along the chain.

Case law denies businesses the right to reclaim VAT when they know or should have known that their transactions are connected with VAT fraud. Such businesses are regarded in law as participants in the fraud and this approach is commonly referred to as the knowledge principle. In applying this principle however, HMRC say it is difficult for them to separate evidence of knowledge from evidence that the business should have known of a connection with fraud.

Current penalty regime

The civil penalties regime determines the level of penalty and requires HMRC to decide whether a business’s non-compliance is ‘deliberate’ or ‘careless’. A ‘deliberate’ penalty implies HMRC think the taxpayer has actual knowledge of their wrongdoing whereas a ‘careless’ penalty suggests that HMRC consider the taxpayer should have known of their connection with fraud.

HMRC’s current practice is to wait until after the VAT case has been finalised before issuing a penalty but this causes two problems to the department:

1. It opens up the opportunity for a second round of litigation, ie an appeal against the penalty, which are costly in both time and money; and
2. The delay in issuing a penalty notice allows time for those involved with the fraud to disperse monies that would be used to pay the penalty.

Proposals


To address the above issue, HMRC want a new penalty that aligns with the knowledge principle and have come up with two suggestions.

Option A – fixed rate penalty

A fixed rate penalty of 30% would be applied when HMRC deny a claim for VAT using the knowledge principle. This would apply whether the business knew or should have known that its transactions were connected with VAT fraud.

Unlike the current regime, there would be no reduction in the level of penalty for disclosure of information to HMRC and the penalty could be collected from company officers such as directors and company secretaries. The rationale for ‘passing the buck’ is that in the vast majority of cases the companies have minimal assets and the masterminds behind the fraud are able to walk away from the company liabilities and start up another fraudulent scheme.

In justifying this approach, HMRC say that they will save themselves £1 million in litigation costs and also around 500 hours in manpower.

Option B – early payment system

This would work in a similar way to Option A but the penalty rate would be 25%. However, if the business appeals and loses in the courts, then the penalty will increase to 50% of the VAT due. HMRC recognise that there may be a concern that this discourages legitimate appeals but says that it is not their intention and invite views on the matter. However, there have been many instances where a taxpayer has taken a frivolous appeal to tribunal and not turned up for the hearing. If this is the case, then why was the appeal allowed by the tribunal in the first case?

Again, there would be no reduction for disclosure because, in HMRC’s experience businesses which facilitate fraud rarely make meaningful disclosures.

Just like Option A, the penalty could be sought from a company officer.

In addition to the financial penalties proposed, HMRC will also consider naming and shaming those who participate in VAT fraud, in the same way that they currently do with deliberate tax defaulters where the penalty involves tax of more than £25K.