Penalties for VAT fraud

HMRC applies penalties to encourage taxpayers to comply with its rules regarding VAT payments. These are intended to serve as a sanction for those who do not comply, while reassuring the majority that they will not be disadvantaged by those who break the rules.

Its penalty principles are as follows:

• The penalty regime is designed from the customer perspective to encourage compliance. Penalties are not applied with the intention of raising revenues.
• Penalties are proportionate to the offence and may take into account past behaviour.
• Penalties are applied fairly, ensuring that compliant customers are in a better position than those who do not comply.
• Penalties are intended to provide a credible threat, which must be raised accurately and must be collected in a cost-efficient manner.
• Customers will see a consistent and standardised approach.

The knowledge principle

Businesses are denied the right to reclaim VAT as input tax when they know - or should have known - that their transactions are connected with VAT fraud. According to the law, these businesses are regarded as participants in the fraudulent activity.

When applying this theory, regarded as the knowledge principle, HMRC will usually issue a decision covering the eventualities that the business had either knowledge of the VAT fraud, or ‘should have known’ of a connection with VAT fraud. On the other hand, the civil penalties legislation requires HMRC to decide when issuing the penalty, whether the business’s non-compliance is “deliberate” or “careless”. This then determines the level of the penalty.

Potential new penalties

HMRC is currently reviewing the types of penalties it rolls out for businesses that do not comply with VAT regulations. We have outlined these below.

Fixed-rate penalty

A fixed-rate penalty of 30% of the VAT due would be applied when HMRC deny input tax, or deny the zero rate for EU supplies using the knowledge principle. The 30% rate would be the same whether the business knew or would have known that its transactions were connected to fraud.

An ‘early payment’ system

This option works very similarly to the fixed-rate penalty, but with a different percentage. A penalty of 25% of the VAT due would be applied when HMRC applies the knowledge principle, where it has been established that a customer knew or should have known that their transactions were connected with VAT fraud.

Naming and shaming

Alongside a penalty, HMRC may consider naming and shaming those that participate in fraud.