What Should I Do if HMRC Is Refusing VAT Repayments and Investigating Me for VAT Fraud?

What Is Carousel Fraud and What Does the Kittel Principle Mean?

Carousel fraud is a form of VAT fraud involving businesses that trade goods through a supply chain to generate fraudulent VAT repayments.

The Kittel principle allows HMRC to deny input VAT deductions where a trader knew or should have known that a transaction was connected to fraudulent VAT evasion.

This can affect businesses that were not directly responsible for the missing VAT.

How carousel fraud works

Missing trader intra-community (MTIC) fraud typically involves goods moving through several businesses, often across international borders.

One business acquires goods without paying VAT, charges VAT when selling them and then disappears without paying the VAT collected to HMRC.

The goods may then pass through other businesses before being exported or sold again, sometimes returning to an earlier part of the chain.

Intermediate businesses are often described as buffer traders.

Carousel fraud commonly involves high-value goods, including mobile phones and electronic components, because they can be traded quickly.

However, fast trading, low profit margins or working in the electronics sector do not automatically establish involvement in fraud.

HMRC must examine the particular transactions and their connection to fraudulent activity.

The Kittel principle and its civil origin

The Kittel principle comes from a European court decision concerning the right to deduct VAT where transactions are connected to fraud.

It remains relevant to UK VAT disputes and has been considered by the Court of Appeal in cases involving alleged MTIC fraud.

Under this principle, HMRC may refuse input VAT recovery where it establishes that a trader knew or should have known their purchase was connected to fraudulent VAT evasion.

You do not necessarily have to be the business that failed to pay VAT for this rule to apply. However, HMRC must establish the required connection between your transactions and the fraud.

The presence of a dishonest business elsewhere in the supply chain is not enough on its own.

What “should have known” means in practice

The question is not simply whether you knew that VAT fraud was a risk in your industry.

HMRC must establish that, considering the circumstances, the only reasonable explanation for your transaction was that it was connected to VAT fraud.

For example, unusual payment arrangements, unexplained third-party payments or deals offering guaranteed profits without a clear commercial reason may raise concerns.

The same may apply where a supplier’s identity, trading history or ability to supply the goods could not be verified.

However, the assessment must consider the circumstances of your actual transactions.

A business cannot be denied input VAT solely because it operated in a market where fraud was known to occur.

Why the civil test and the criminal standard are different

HMRC can deny input VAT under the Kittel principle through civil tax proceedings.

The civil standard is the balance of probabilities. HMRC does not have to prove that you acted dishonestly. Criminal proceedings are different.

The prosecution must establish the elements of the particular criminal offence beyond reasonable doubt.

For example, fraud by false representation requires proof of a knowingly false or misleading representation, dishonesty and the intention to make a gain or cause loss.

Fraudulent evasion of VAT has its own statutory requirements, including knowing involvement in fraudulent evasion.

A civil finding that you knew or should have known about VAT fraud does not automatically establish criminal guilt.

What Due Diligence Records Can Help Me Challenge HMRC’s Findings?

Records that show what checks you carried out at the time of each transaction are the most useful evidence when challenging HMRC’s conclusion that you knew or should have known of a connection to fraud. 

Due diligence is not an automatic answer, but it is evidence that can help displace the inference that the only reasonable explanation for a trade was VAT fraud.

What HMRC expects from traders

HMRC expects businesses engaged in wholesale trading of high-value goods to carry out proportionate due diligence before transacting. 

This includes verifying that suppliers and customers are VAT-registered using HMRC’s online VAT number checker, reviewing contracts and commercial terms, examining purchase orders, proforma invoices and delivery documentation, and maintaining a clear audit trail for each deal.

The standard of due diligence expected is proportionate to the value and risk profile of the transaction. 

A single low-value purchase attracts different scrutiny from a series of high-volume, fast-turnaround deals in a market sector known to be a target for MTIC VAT fraud. 

The absence of proportionate checks in a high-risk context can support a finding that the trader should have known of a connection to fraud.

Records that can support your position

Preserve every document connected to each transaction. 

Invoices, bank statements, payment records and evidence of fund flows between parties provide the financial trail for individual deals.

Transport documents, inspection reports, delivery notes and, where goods are serialised, IMEI or serial number records help establish that specific goods moved through the chain on specific dates.

Contemporaneous correspondence matters considerably.

Emails, written correspondence and messaging records created at the time of each deal show the instructions you received, the questions you asked and the information available to you when you decided to trade. 

Due diligence files assembled before transactions completed carry more weight than documents compiled after HMRC raised its first concerns about VAT fraud.

The limits of due diligence as a standalone answer

Performing checks does not automatically protect a trader from a Kittel finding. 

The First-tier Tribunal weighs due diligence as one feature among others when assessing whether a trader knew or should have known of a connection to VAT fraud. 

• Checks that were inadequate, incomplete or not genuinely carried out can be used by HMRC to support its case that the trader should have known. 
• Checks that were thorough and consistent with the nature and scale of the trading relationship provide better evidence in the trader’s favour.

How existing records are assembled, ordered and presented to HMRC or to the tribunal can affect how they are received. 

Obtaining professional advice on disclosure before supplying documents is important. Records disclosed in civil proceedings may also become relevant in any parallel criminal VAT fraud investigation.

Can I Challenge HMRC’s VAT Decision During a Criminal Investigation?

Yes. You may be able to challenge HMRC’s refusal of VAT repayments while a related criminal investigation is underway.

However, the appropriate route depends on what HMRC has actually decided.

A repayment held for verification is different from a formal decision denying your entitlement to input VAT.

Held versus formally denied: understanding the difference

HMRC may delay a VAT repayment while it checks invoices, suppliers, transaction records or the legitimacy of a claim.

At that stage, HMRC may not yet have made a formal decision about your entitlement.

If the repayment is still being verified, your immediate options may involve responding to information requests, challenging unreasonable delay or seeking clarification about the investigation.

However, not every withheld repayment is necessarily beyond challenge. The available remedy depends on the legal basis for HMRC’s action.

If HMRC formally denies input VAT or issues an assessment, statutory review or appeal rights may arise.

Check the wording of the decision and whether it includes an explanation of how to challenge it.

The 30-day appeal deadline under section 83G VATA 1994

You generally have 30 days from the date of an appealable VAT decision to appeal to the First-tier Tribunal or accept an offered statutory review.

If you accept a review in time, the tribunal appeal deadline generally runs from the conclusion of that review rather than continuing unchanged from the original decision.

Where a review confirms HMRC’s position, you normally have a further 30 days from the review outcome to appeal. A late appeal may be permitted, but you must obtain the tribunal’s permission.

For example, if HMRC has issued a decision denying a substantial input VAT claim, you should establish the deadline immediately rather than assume that discussions with HMRC will preserve your appeal rights.

Your solicitor can advise whether to seek a statutory review or appeal directly to the tribunal.

Privilege, self-incrimination and responding to HMRC

Information provided during a civil VAT dispute may also become relevant to a criminal investigation. This means responses to HMRC’s questions should be considered carefully where you face both types of proceedings.

Confidential communications with a solicitor for the purpose of obtaining legal advice are generally protected by legal professional privilege, subject to applicable limits.

The privilege against self-incrimination may also be relevant in some circumstances, although it does not automatically remove obligations to provide records under HMRC’s statutory powers.

If you receive a formal information notice or an invitation to an interview under caution, obtain advice about your obligations and rights before responding.

Can the Tax Tribunal Case and Criminal Investigation Run at the Same Time?

Yes, the two proceedings can run simultaneously. 

A stay of the First-tier Tribunal to await the outcome of criminal VAT fraud proceedings is not granted automatically, and courts have declined to stay tribunal proceedings where the factual overlap between the two cases is limited or where staying would cause injustice to one of the parties.

How the two tracks operate

The First-tier Tribunal applies the civil standard of proof. It determines whether HMRC was correct to deny input tax deduction on Kittel grounds based on the balance of probabilities. It does not decide criminal guilt. 

Criminal proceedings in the Crown Court apply the criminal standard: the jury must be satisfied beyond reasonable doubt that the defendant is guilty of VAT fraud under the Fraud Act 2006. 

The evidence rules, disclosure obligations and consequences in each track are different.

A finding against a trader in the tribunal does not constitute a conviction and cannot be used as proof of criminal guilt in a Crown Court trial. 

Equally, a jury acquittal in criminal proceedings does not automatically reverse a Kittel-based denial of input tax in the tribunal, because the two proceedings apply different standards and address different questions.

Coordinating responses across both proceedings

Statements and documents produced for the tribunal may become relevant in criminal VAT fraud proceedings, and information obtained by HMRC through its civil powers may feed into a criminal investigation. 

A solicitor with experience across both civil tax litigation and criminal defence can coordinate the approach to each set of proceedings, advise on what to disclose and when, and identify where responses in one track could affect the other.

Managing parallel proceedings without coordinated legal advice creates a material risk of inadvertent prejudice. 

The two proceedings do not wait for each other, and decisions made in one can have consequences in the other.

What Penalties and Sentences Could I Face for VAT Fraud?

The consequences depend on whether HMRC is pursuing a civil VAT dispute, a criminal prosecution or both.

A refusal of input VAT does not automatically result in a criminal penalty.

However, where criminal fraud is proved, the consequences may include imprisonment, financial orders and confiscation proceedings.

Criminal sentencing under the Fraud Act 2006

Fraud by false representation under the Fraud Act 2006 carries a maximum sentence of ten years’ imprisonment in the Crown Court.

However, carousel fraud may also be prosecuted as fraudulent evasion of VAT under the Value Added Tax Act 1994.

That offence carries a maximum sentence of fourteen years‘ imprisonment in the Crown Court under the current legislation.

The charge depends on the alleged conduct and the available evidence.

Courts consider factors including the amount involved, planning, the defendant’s role and the harm caused.

A person accused of organising a substantial fraudulent trading chain may face a different sentencing assessment from someone whose involvement was limited.

The statutory maximum is not the sentence automatically imposed following conviction.

Civil recovery of VAT, interest and penalties

If HMRC establishes that your business was not entitled to input VAT, it may seek recovery of the amount claimed or reduce a repayment otherwise due.

Interest may also apply where the statutory requirements are met.

Separate civil penalties can arise where inaccurate returns or other relevant breaches are established.

However, the fact that input VAT has been denied under the Kittel principle does not automatically establish that a penalty is due.

HMRC must identify the legal basis for each penalty and satisfy its requirements.

Where criminal proceedings concern the same conduct, the interaction between penalties and prosecution also requires careful assessment.

Confiscation under the Proceeds of Crime Act 2002

A criminal conviction may lead to confiscation proceedings under the Proceeds of Crime Act 2002.

The court can assess the financial benefit obtained from criminal conduct and determine the amount recoverable.

Where the statutory criminal lifestyle provisions apply, the assessment may extend beyond the transactions directly involved in the conviction.

A confiscation order is separate from a fine or custodial sentence.

Failure to pay may lead to enforcement action and, in certain circumstances, a default custodial term.

The amount and consequences depend on the statutory requirements and the defendant’s circumstances.

How a Specialist Solicitor Can Help With a VAT Fraud Investigation

If HMRC is withholding your VAT repayments and alleging that your transactions were connected to carousel fraud, a solicitor can examine the evidence and establish which proceedings you are facing.

They can review HMRC’s application of the Kittel test, assess your due diligence records and consider whether there are grounds to challenge the refusal of input VAT.

A solicitor can also advise on statutory reviews, tribunal appeals and the deadlines involved.

Where a criminal investigation is underway, they can assess the allegations separately, advise before interviews under caution and coordinate the handling of evidence across both proceedings.

Our fraud and financial crime team can advise on the allegations, your available options and the next steps.