Penalty for participating in VAT fraud

HMRC published a consultation paper at the end of September seeking proposals (until 11 November 2016) on the implementation of a new penalty for businesses that participate in VAT fraud.

The proposal aims to address the different process between the ‘knowledge’ principle of denying the right to reclaim input tax and the civil penalties legislation.

Based on established principle borne out through case law; businesses are denied the right to reclaim input tax, or zero rating for EU transactions when they know, or should have known, that the transactions are connected with VAT fraud; the businesses in question are seen as participants to the fraud. In practice HMRC issue decisions covering both eventualities to avoid having to provide evidence that a business either ‘knows’ or ‘should have known’ of a connection with VAT fraud.

This practice is at odds with the civil penalties legislation (Schedule 24 of FA2007) that requires HMRC to decide when issuing the penalty, whether a business’ non-compliance is ‘deliberate’ (implies actual knowledge) or ‘careless’ (implies they should have known).

Currently HMRC need to establish that the business had actual knowledge of the fraud to levy a ‘deliberate’ penalty, or, in the case of the ‘careless’ category, establish that the business should have known of the connection with fraud. Because of the difficulty of distinguishing between careless and deliberate behaviour HMRC will delay issuing a penalty until the substantive fraud issue is finalised, including any litigation (which can, in some cases last for several years). This can result in a second round of litigation against the penalty which is both time consuming and costly and often at the point of being resolved there is no money left to pay any penalty levied.

The proposals are for a new penalty to align with the knowledge principle that can be issued at the same time as the decision in the underlying VAT fraud case and doesn’t rely on the distinction between whether a business knew or should have known of the connection to fraud.

The consultation seeks comments on the introduction of such a penalty, as well as comments on its proposed design; HMRC is proposing two main options:

• Option A – a fixed rate penalty of 30% of the VAT due when HMRC deny input tax (or where zero rate for EU supplies is denied) for all cases where the knowledge principle is applied; removing the scope for two tribunal hearings (one for the VAT case and one for the penalty) on the same issue. In line with the knowledge principle, the 30% rate would be the same whether the business knew or should have known of the connection with fraud, or
• Option B – an ‘early payment’ system with a lower 25% rate initially when HMRC apply the ‘knowledge principle’; that a business knew or should have known that its transactions were connected with fraud. If the business appeals the knowledge decision, loses the case and a finding of actual knowledge is determined by the courts, then the penalty will increase to 50% of the VAT due. HMRC makes the point that that they are mindful of concerns that this option may be seen as discouraging legitimate appeals and welcome comments.

HMRC’s preference is for both options to be able to target company officers as well as the company itself. They see this as providing an effective way of ensuring a better rate of recovery from companies that own few assets, as well as targeting individuals that mastermind the VAT fraud; preventing them walking away from company liabilities and starting a fraudulent scheme all over again.

They invite opinion on whether the new penalty regime should apply to company officers in cases where they should have known as well as with actual knowledge of the connection with VAT fraud. Currently Schedule 24 penalties only apply to company officers where there is evidence of deliberate behaviour.

Both of the main proposals don’t provide for reductions in the level of penalty for disclosure of information or cooperation with HMRC. HMRC opinion is that businesses which facilitate VAT fraud rarely make meaningful disclosures. Other options mentioned in the proposal touch on this point and they invite opinion on whether there should be any reductions in the level of penalty for co-operating with HMRC.

Views are also sought on whether ‘naming and shaming’ is a suitable sanction to be applied where the participant ‘should have known’ about the fraud, as well as where there is actual knowledge. Current practice is to publish details of deliberate tax defaulters, when the penalty involves tax of more than £25,000.

HMRC will be seeking views on the detailed policy design for any new penalty and there will be a further consultation on any draft legislation following the Autumn Statement (scheduled for 23 November 2016).