Is Dishonesty the Best Policy?
In the coming months the Court of Appeal, and a strong Court of Appeal at that (consisting of The Master of the Rolls, The Chancellor and Hallett LJ), will hand down its judgment in HMRC v E Buyer (UK) Ltd & Citibank NA. It is hoped that this will settle a fundamental dispute that has been festering since the well-known principle in Kittel was promulgated by the CJEU in 2006: does dishonesty have any role to play in deciding whether to deny a taxpayer the right to deduct input tax under the Kittel principle?
The principle in Kittel allows HMRC to deny the taxpayer the right to deduct input tax where the transaction on which the tax is claimed is connected with fraud and for which the taxpayer knew, or should have known, of that fact. HMRC have long argued that all they must prove is a state of knowledge, as opposed to dishonesty, and the taxpayer has long argued that either an allegation of actual knowledge is one of dishonesty, or that the facts on which HMRC rely are only consistent with dishonest conduct.
The problem arises because the CJEU refuses to get drawn into matters of national procedure. The CJEU is trying to create a harmonised, one size fits all principle to combat VAT fraud that poses a serious problem for the coffers of Member States. The CJEU does not care how such principles are brought into the real world in each Member State, as long as they are brought in. However, anything with a connotation or suggestion of fraud stirs the English common lawyer into a frenzy about pleadings, whether the frenzy is justified or not. The interface between the English common law principles about pleading fraud and whether or not dishonesty is a requisite element of Kittel is the tangle that the Court of Appeal must now unknot.
The principle in Kittel, as interpreted by the Court of Appeal in Mobilx Ltd & Ors v HM Revenue & Customs [2010] EWCA Civ 517 represented, in part, a real change in how cases with a whiff or element of fraud to them were dealt with by the First-tier Tribunal (Tax Chamber). For one, Moses LJ decided without any reference to the authorities, that since HMRC wished to allege that a taxpayer’s state of mind took it outside of the right to deduct input tax, HMRC would have the burden of proof. Arguably, this tore up decades of settled law. In Brady v Group Lotus Companies PLC [1987] WL 493342 Mustill LJ said: Khan v HMRC
“Here, however, unacceptable the idea may be to the ordinary member of the public, it has been clear law binding on this court for sixty years that an Inspector of Taxes has only to raise an assessment to impose on the taxpayer the burden of proving that it is wrong: T. Haythornthwaite & Sons v. Kelly [1927] 11 Tax Cas. 657.”
Carnwath LJ (as he then was) cited Brady in [2006] EWCA Civ 89, saying:
“It should be noted that this burden of proof does not change merely because allegations of fraud may be involved (see e.g. Brady v Group Lotus Car Companies plc [1987] STC 635, 642 per Mustill LJ).”
Since Mobilx, and the imposition of the burden of proof, there has been a linked struggle to reconcile the true requirements of the Kittel test and the requirements of pleadings in cases concerning fraud. The prevailing view had been largely that HMRC were right, that they were not alleging fraud or similar against the taxpayer and that what they were alleging was a state of knowledge. The first instance decision in Ebuyer was a good example of this. However, the First-tier Tribunal (Tax Chamber) came to the opposite conclusion in Citibank and the Upper Tribunal decided that the Citibank Tribunal was right.
The Court of Appeal’s decision will not touch upon the burden of proof but it should provide, in part, the answer to the knotty question of whether dishonesty is part of the Kittel test. The fallout may be significant. Plainly if the Court of Appeal decides that HMRC needs to plead and prove dishonesty that will make it harder for HMRC to use the Kittel principle. The pleadings war will doubtless renew with greater intensity. By contrast, a restatement of the simple principle may put to bed a variety of arguments that have been used by taxpayers, for both good and for bad reasons.
The decision may not just affect cases decided under the Kittel principle. It will, for example, affect the power to refuse zero-rating on supplies connected with fraud under the principle in Mecsek-Gabona. It may also have a spill-over effect into how tax cases are pleaded in general. For example, in any “no supply” cases there is always the whiff of fraud, albeit HMRC do not have to prove fraud to get their case home.
Howard Watkinson
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