Successful Kittel Tribunal Appeal 2025

VAT Fraud in Payroll Outsourcing – The Kittel Principle

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Here’s a summary of the UK First-tier Tribunal (Tax) Kittel judgment in Cheema Construction Services Ltd & Anor v Revenue and Customs [2025] UKFTT 92 (TC), decided on 28 January 2025:

Case Overview

  • Parties: Cheema Construction Services Ltd (CCSL) and its sole director, Mr Kulminder Cheema (Appellants) vs. HM Revenue and Customs (HMRC) (Respondents).
  • Issue: HMRC denied CCSL’s right to deduct input VAT (£315,142.65) for periods 01/20 to 07/21, alleging the transactions with supplier Woodside Contracts Ltd were connected to fraudulent VAT evasion under the Kittel principle. HMRC also imposed penalties on CCSL (£236,356) and Mr Cheema (£157,571).
  • Decision: The Tribunal allowed the appeals, overturning HMRC’s decisions.

Background

  • CCSL’s Operations: Incorporated in 2009, CCSL supplies construction labour (e.g., concrete formwork) by hiring workers from labour suppliers like Woodside and supplying them to customers. Mr Cheema has been the sole director since inception.
  • HMRC’s Allegation: HMRC claimed CCSL’s transactions with Woodside were linked to fraudulent VAT evasion by five companies (Fraudulent Defaulters: Daniella Enterprises Ltd, Dione Traders Ltd, Sandhar Consultancy Ltd, Build Wise Ltd, Build 247 Ltd), asserting CCSL knew or should have known of this connection.

Legal Framework (Kittel Principle)

Under Kittel v Belgium (CJEU), a taxpayer loses the right to deduct input VAT if:

  1. There was a VAT loss.
  2. The loss resulted from fraudulent evasion.
  3. The taxpayer’s transactions were connected to that evasion.
  4. The taxpayer knew or should have known of the connection.
  • Cheema conceded points 1 and 2 (VAT loss and fraud by the Fraudulent Defaulters), so the Tribunal focused on points 3 (connection) and 4 (knowledge).

Key Issues and Findings

  1. Connection to Fraudulent Evasion
  • HMRC’s Case: HMRC argued that Woodside sourced all its labour from the Fraudulent Defaulters, linking CCSL’s transactions to the tax loss (Fraudulent Defaulter → Woodside → CCSL → customer).
  • Cheema’s Case: CCSL challenged this, pointing to discrepancies between Woodside’s VAT returns (£1,003,656.85 output tax) and CIS returns (£747,666.80 expected output tax), suggesting £255,990 of Woodside’s supplies were not from the Fraudulent Defaulters. CCSL’s input tax (£261,432.65) closely matched this “extra” amount, raising doubt about the source.
  • Tribunal Finding: The Tribunal found HMRC failed to prove, on the balance of probabilities, that CCSL’s transactions with Woodside were connected to the Fraudulent Defaulters. Alternative explanations involving Woodside’s own employees or other suppliers were plausible, and HMRC did not investigate this further. This finding alone was sufficient to allow the appeal.
  1. Knew or Should Have Known

Though not necessary given the connection finding, the Tribunal addressed this for completeness:

  • HMRC’s Evidence: HMRC cited prior deregistration notices (Dereg Veto Letters), HMRC visits, due diligence guidance, and indicators like early payments and invoice issues as showing CCSL’s awareness of fraud risks.
  • Appellants’ Response: Mr Cheema acknowledged receiving warnings but denied knowledge of Woodside’s fraud link. Due diligence included VAT/CIS checks and contracts, though some efforts (e.g., premises visits) were lax.
  • Tribunal Finding: The Tribunal found HMRC did not prove CCSL knew or should have known of a fraud connection. Historical warnings were insufficiently linked to Woodside, and circumstantial evidence involving payments, invoices etc. had legitimate explanations. The labour supply industry has a legitimate sector, and HMRC failed to show the “only reasonable explanation” was fraud.

Outcome

  • Input Tax Denial: The Tribunal allowed CCSL’s appeal, restoring its right to deduct £315,142.65 in input VAT.
  • Penalties: As the Kittel denial was overturned, the penalties on CCSL (£236,356 under VATA 1994 s.69C) and Mr Cheema (£157,571 under s.69D) were also set aside.
  • Reasoning: HMRC bore the burden of proof and failed to establish connection or knowledge on the civil standard (balance of probabilities).

Significance

  • The case highlights the importance of HMRC proving each Kittel element with evidence, not assumption. Discrepancies in supplier records (VAT vs. CIS) and failure to explore alternative explanations undermined HMRC’s case.
  • It also underscores that due diligence, while relevant, is not decisive – Tribunals must assess the totality of evidence holistically.

For further comment on this case or general advice regarding either protecting yourself from being connected to fraud in the payroll sector, or appealing HMRC’s decision to deny input tax, please speak directly to our Kittel specialist, Liban Ahmed (Tax Director), on 07738 666548 or email liban@ctmlaw.co.uk.

Liban has spent 80% of his time involved in Kittel cases at all stages for the past 17 years and can provide invaluable, initial advice at no cost.

This is a highly specialist area and each case requires specific, tailored advice.