Certain transactions between EU states are value-added tax (VAT) free, and exporting firms can apply to the HM Revenue and Customs (HMRC) for a VAT refund on those items. However, if VAT fraud is suspected anywhere in the supply chain, even innocent firms can find VAT refunds delayed or ultimately denied.
Missing Trader Intra-Community (MTIC) or ‘carousel fraud’ is a prime target for HMRC VAT fraud investigations. The critical legal test applied by courts to traders that are either party to or innocently caught up in carousel fraud is the ‘means of knowledge test’.
A quick overview of carousel fraud
Carousel fraud occurs when an EU business exports to a UK acquirer. Generally, that UK firm owes the HMRC VAT following onward sale of the goods. Often though, the original acquirer does not actually exist or will disappear, meaning the tax is unpaid.
The goods will then be passed through a series of buffer companies, which will pay appropriate tax to HMRC, but these down-the-line taxes are much smaller in amount. Finally, a broker will export the goods out to another EU state and receive a large reimbursement from the HMRC, including the amount the original UK importer should have paid but did not.
What is the means of knowledge test?
When HMRC prosecutes a carousel fraud case, the courts rely on a ‘means of knowledge’ test to determine the liability of each firm in the chain.
The test is also known as the Kittel principle from the 2006 cases of Axel Kittel v Belgium and Belgium v Recolta Recycling. In Kittel the ECJ held that traders must be able to rely on legally deducting input VAT as long as they objectively took every reasonably required precaution against fraudulent links in the supply chain.
Simply knowing that VAT fraud is prevalent in a trade industry, such as mobile phone trade, is insufficient to demonstrate fraud and disallow input VAT reimbursement for each link in the chain.
In Kittel the court held that each trader must know or objectively should have known that at least one participant in the supply chain was a fraudster and prosecutors must prove that fraud would be the only reasonable explanation. Thus, even if fraud is proved for one trader in a supply chain link, it does not automatically follow that all taxpaying firms in the supply chain are liable for MTIC fraud and will not receive any input VAT reimbursement they apply for.
The court summarised:
“Where it is ascertained, having regard to objective factors, 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 fraudulent evasion of VAT, it is for the national court to refuse that taxable person entitlement to the right to deduct.”
Summary of the means of knowledge test
In order for the HMRC to prevail using the means of knowledge test, it must show:
- A demonstrated VAT loss from fraudulent evasion of tax.
- The transactions of the firm under investigation must be connected to fraudulent VAT evasion.
- The firm must have known or objectively should have known the transactions were connected to VAT fraud after taking reasonable precautions.
If you or your business is facing an EVP, a VAT investigation or prosecution for engaging in VAT fraud it is vital that you seek expert legal advice at the earliest opportunity. For more information call today on 01616 966 229 to speak to our serious fraud solicitors or complete an online enquiry form and a member of the team will contact you directly.