UK ‘Naive’ trader loses Kittel VAT case

The case summons the Kittel principle (European Court of Justice’s decision in Axel Kittel (C-439/04 and C-440/04)) where mere ignorance of a VAT fraud may not be sufficient defence.

In the case of Zed-UK Ltd, a small retailer of Apple AirPods and IT accessories, HMRC successfully denied over £194,000 in input VAT and levied a £58,000 penalty under the Kittel principle, leaving the company with a total liability of more than £250,000.

For any business involved in cross-border supply chains, robust due diligence and VAT risk management are not optional—they are essential to avoid falling victim to the Kittel principle.

The Case: From Fishing Hooks to High-Value Electronics

Zed-UK Ltd started as a small-scale eBay and Amazon trader selling fishing hooks and computer thermal paste from his parents’ garage. In 2020, the company shifted to buying Apple AirPods and IT gadgets from Digi C Associates Limited, a supplier that was later dissolved, and selling the goods to buyers across Europe.

HMRC determined that Zed-UK’s transactions formed part of a missing trader intra-community (MTIC) fraud chain, also known as a carousel fraud. The FTT found that Digi C was effectively under the control of a fraudster and that Director of Zed-UK was a “passenger” in the fraudulent scheme. Despite his lack of experience, HMRC argued that he should have known the transactions were connected to VAT fraud, and therefore his company could not reclaim the input VAT on purchases.

HMRC’s Approach to VAT Fraud in Supply Chains

HMRC takes a strict approach to parties involved in VAT fraud chains, particularly in high-risk sectors like electronics, IT goods, and luxury items.

The department regularly denies input VAT recovery to any trader who knew or should have known that their transactions were connected to VAT fraud. This reflects the UK’s adoption of the EU Kittel principle, stemming from the European Court of Justice’s decision in Axel Kittel (C-439/04 and C-440/04).

Under Kittel, a business loses the right to recover input VAT if:

1. It knew, or should have known, that the transaction was part of a scheme to fraudulently evade VAT, and

2. The transaction formed part of a chain where VAT was deliberately not paid, usually by a missing or “buffer” trader.

This standard puts the onus on businesses to conduct rigorous due diligence on their suppliers and customers, especially in high-risk markets.

What is “Fraudulent Evasion of VAT”?

Fraudulent evasion of VAT occurs when a party in a supply chain deliberately avoids paying VAT due to HMRC, often by:

• Missing trader fraud, where a business imports goods VAT-free, sells them domestically with VAT, and then disappears without remitting the VAT.

• Carousel fraud, where the same goods circulate through multiple companies, generating repeat VAT reclaims before one party vanishes.

The fraudulent evasion of VAT lies with the party that deliberately fails to pay HMRC. However, the financial consequence extends to any other party in the chain who should have realised the fraud was occurring, even if they did not actively participate.

Tribunal’s view – failed to spot fraud warning signs

The FTT considered whether the Director of Zed-UK’s lack of sophistication was a valid defence. Despite acknowledging that he had little business knowledge and was effectively a “passenger” in the transactions:

• He failed to carry out adequate due diligence on Digi C Associates.

• He ignored warning signs, such as unusually low prices and payment structures typical of high-risk VAT supply chains.

The tribunal concluded that Zed-UK “should have known” the transactions were connected to VAT fraud. As a result:

1. Input VAT of £194,651 was denied.

2. A penalty of £58,395 was upheld under s69C VATA 1994, bringing the total to £253,046.

Although HMRC had initially issued a personal liability notice (PLN) to Director of Zed-UK, attempting to hold him personally responsible under s69D VATA 1994, this was later withdrawn.