Tribunal Upholds Decision that Appellants Connected to VAT Fraud through Knowledge and Due Diligence

Introduction

In the First-tier Tribunal case of Minstrell Recruitment Limited & Ors v The Commissioners for HMRC, various legal principles were scrutinized to determine whether the appellant was involved in transactions connected to fraudulent evasion of VAT. The case provides an analytical legal framework for addressing the issue of knowledge in the context of VAT fraud, most notably relying on the Kittel principle, and by extension, the due diligence expected of taxpayers in similar circumstances.

Key Facts

Minstrell Recruitment Limited (MRL) and two associated companies appealed against HMRC’s decisions on the grounds of a denied entitlement to deduct input tax claimed on the purchase of labor. This was due to the transactions being connected with fraudulent evasion of VAT. HMRC also decided not to register two of Minstrell’s companies for VAT, anticipating they would be used for fraudulent purposes. The three supplier companies involved were Crystal Clear Contract Services Limited (Services), Crystal Clear Contracts Limited (Crystal), and Clarity All Trades Limited (Clarity).

The Tribunal needed to establish whether there were VAT losses, if such losses were the result of fraud, if the transactions in question were connected to that fraudulent tax loss, and if MRL knew or should have known about the connection to fraud.

Legal Principals

The Tribunal’s analysis was guided by a series of established legal principles:

1. Kittel Principle: Central to the case was the application of the Kittel principle, which deems a taxable person who knew or should have known they were partaking in a transaction connected with VAT fraud, as a participant in that fraud (Axel Kittel v Belgian State; Belgian State v Recolta Recycling SPRL (C-439/04 and C-440/04)).

2. Means of Knowledge: In accordance with Mobilx Ltd v HMRC (2010), the Tribunal considered the “means of knowledge” available to the taxpayer, suggesting that failure to act on available knowledge could lead to a denial of VAT deduction rights.

3. HMRC’s Burden of Proof: HMRC had to establish on the balance of probabilities that the appellant knew or should have known of the fraud (Mobilx at [81] and [82]).

4. Phoenix Companies: HMRC argued that the companies in question were “phoenix companies,” set up to continue the fraud perpetuated by MRL, a notion buttressed by the principle in Mobilx and the CJEU case of Halifax plc v Commissioners of Customs and Excise (C-255/02).

5. Conduct of Directors: The Tribunal also took into account the role that directors, shadow directors, or those in similar positions, played in the knowledge and conduct of the transactions in question.

Outcomes

The Tribunal dismissed the appeals, concluding that MRL, indeed, knew or should have known that their transactions were connected with the fraudulent evasion of VAT. It was established that VAT losses occurred, and they were incurred by fraud. The transactions were directly linked to such fraudulent tax losses, and the director’s connections and control over the supplier companies indicated clear knowledge of the fraudulent nature of the transactions. MRL and its directors failed in exercising due diligence corresponding to the level of suspicions that the transactions aroused.

Conclusion

The Tribunal’s decision reinforces the stringent obligations placed on companies to ensure their transactions do not involve VAT fraud. The judgment reiterates the imperative for companies to conduct adequate due diligence on their transactions, which extends to knowing the entities they transact with. In cases where connections between companies and their directors are evident, the knowledge of fraudulent activities is presumed to be shared among these closely-linked entities. This case sets a precedent that negligence or ignorance cannot be a defense where there is ample opportunity and means to know about fraudulent dealings.