Introduction

The case of HM Revenue and Customs v. Citibank NA & Anor ([2018] WLR 1524) adjudicated by the England and Wales Court of Appeal (Civil Division) on September 29, 2017, addresses critical issues surrounding the deduction of input VAT in the context of VAT fraud, specifically Missing Trader Intra-Community (MTIC) fraud. The appellants, Citibank NA and E Buyer UK Limited, challenged HMRC's assertions that their transactions were part of orchestrated schemes to defraud VAT. The central legal dispute revolved around whether HMRC must plead and prove dishonesty when alleging that a taxpayer knew or should have known about the fraudulent nature of their transactions under the Kittel test.

Summary of the Judgment

The Court of Appeal dismissed HMRC's appeal in the Citibank case, finding that the Upper Tribunal (UT) erred in equating knowledge with dishonesty. Conversely, the UT's decision regarding E Buyer was overturned, reinstating Judge Walters' direction for standard disclosure rather than the broader disclosure HMRC sought. The judgment clarifies that under the Kittel test, which focuses on knowledge (actual or constructive) of fraud, HMRC is not obligated to allege dishonesty unless it explicitly intends to do so. This distinction ensures that taxpayers are not subjected to unwarranted procedural burdens when HMRC bases its case solely on knowledge without alleging dishonesty.

Analysis

Precedents Cited

The judgment extensively references key legal precedents that shape the interpretation and application of the Kittel test in VAT fraud cases:

• Kittel v. Belgium (C-439/04 and C-440/04): Established the Kittel test, delineating that a taxpayer cannot reclaim input VAT if they knew or should have known their transactions were linked to fraudulent VAT evasion.
• Halifax plc v. Customs and Excise Commissioners (C-255/01): Introduced the "Halifax principle," emphasizing that abusive tax practices preclude the deduction of input VAT.
• Megtian Ltd v. HMRC [2010] EWHC 18 (Ch): Asserted that knowing participation in VAT fraud implies a dishonest state of mind.
• Mobilx Ltd v. Revenue and Customs Commissioners [2010] EWCA Civ 517: Highlighted that the Kittel test focuses on knowledge rather than dishonesty.
• Red 12 Trading Limited v R&C Commissioners [2009] EWHC 26523 (Ch): Provided guidance on assessing knowledge within the Kittel test without conflating it with dishonesty.
• Livewire Telecom [2009] EWHC 15 (Ch): Emphasized that the Kittel test does not equate to an honesty test and clarified the distinction between knowledge and dishonesty.

Legal Reasoning

The Court of Appeal dissected the UT's reasoning, particularly focusing on its conflation of knowledge with dishonesty. The UT had held that alleging actual knowledge under the first limb of the Kittel test implies an accusation of dishonesty, thus requiring HMRC to plead and prove dishonesty explicitly. The Court of Appeal disagreed, asserting that the Kittel test is fundamentally about knowledge—actual or constructive—and does not inherently encompass dishonesty unless HMRC explicitly alleges it.

The judges highlighted that while certain transactions within MTIC fraud schemes may suggest dishonesty, the mere knowledge of fraud does not automatically equate to it. Therefore, HMRC should not be forced to plead dishonesty unless it explicitly intends to do so. This ensures procedural fairness and prevents unnecessary burdens on taxpayers in cases where HMRC's case is solely based on knowledge without alleging dishonesty.

Impact

This judgment significantly impacts future VAT fraud cases by clarifying the application of the Kittel test. HMRC can base its case on knowledge without the procedural requirement to allege dishonesty unless it chooses to. This delineation streamlines legal processes, ensuring that allegations are handled with appropriate specificity and avoiding the conflation of knowledge with dishonesty unless substantively justified. Consequently, tribunals and courts will have a clearer framework for assessing VAT fraud allegations, enhancing legal certainty and fairness for taxpayers.

Complex Concepts Simplified

MTIC Fraud

Missing Trader Intra-Community (MTIC) fraud involves a chain of businesses across EU member states that exploit the VAT system. Typically, goods are imported VAT-free by a trader who then sells them with VAT to another trader, who disappears without remitting the VAT to HMRC. This creates a "carousel" of transactions that defrauds the tax system.

Kittel Test

The Kittel test determines whether a taxpayer can reclaim input VAT when their transactions are connected to VAT fraud. It has two limbs:

• First Limb: The taxpayer knew that their transaction was part of a fraudulent scheme.
• Second Limb: The taxpayer should have known, based on the circumstances, that their transaction was fraudulent.

Dishonesty in Civil Proceedings

In civil law, dishonesty requires a combination of an objective element (contrary to reasonable standards of honesty) and, in some cases, a subjective element (awareness of wrongdoing). However, under the Kittel test, HMRC is not required to allege dishonesty unless it chooses to explicitly do so.

Conclusion

The judgment in HM Revenue and Customs v. Citibank NA & Anor sets a pivotal precedent in VAT fraud litigation by clarifying that the Kittel test is fundamentally about knowledge of fraudulent transactions without necessitating an allegation of dishonesty unless explicitly intended by HMRC. This distinction enhances procedural fairness, ensuring that taxpayers are not unduly burdened by implicit accusations of dishonesty. Moving forward, HMRC must clearly state its intentions regarding dishonesty in its pleadings, thereby fostering greater clarity and judicial efficiency in handling complex VAT fraud cases.