An honest business can find itself forced to close as a result of HMRC’s extended verification of input tax claims. There are surprisingly few tools such businesses can use to defend themselves.
This important issue can arise for VAT registered businesses which make supplies to customers outside the EC. Their supplies of goods or services will usually fall outside the scope of VAT. If the business incurs significant input tax in purchasing the goods or services from UK suppliers, their VAT returns will show a net VAT claim from HMRC.
HMRC has a responsibility to protect the revenue, which includes investigating claims. Whilst HMRC is investigating potential VAT frauds by others in potentially remote parts of a supply-chain, it will not pay claims made by honest businesses further down the supply chain. These honest businesses will find themselves deprived of more funds with each passing VAT return and, if this situation persists for long, it will be increasingly difficult for these businesses to continue operating. Many will ultimately fail before HMRC has concluded its “extended verification” investigation.
Whilst VAT fraudsters are rightly pursued vigorously by HMRC, businesses who have made their best efforts to conduct sensible due diligence should assert their right to repayment.
Judicial Review is usually of little assistance, in our experience, with the court’s view being that HMRC is entitled to withhold repayment whilst conducting an “extended verification”. However, a defence can be mounted using the ‘means of knowledge’ test, which is set out in Axel Kittel v Belgium  ECJ C‑439/04 and C‑440/04. In summary, the test is whether the business knew, or should have known, that the transactions in question were connected to a VAT fraud.
This issue can affect all sectors of the economy, but we understand that recent industries affected include the following:
- Photographic equipment
- Household goods (especially razor blades)
- Soft drinks
- Scrap metal
- Aircraft parts
- Telephone lines