The Kittel Principle: MTIC Input Tax Denial & PLN Defence

The Kittel principle is the foundation of HMRC’s most aggressive tool against VAT fraud: denial of input tax to any trader in a fraudulent supply chain who knew or should have known, of the connection to fraud. But the same case contains a critical protection that many advisers underuse. This guide analyses the Kittel test, the mechanics of MTIC supply chain fraud, the reasonable-steps defence and, crucially, why a “should have known” finding on the assessment does not automatically justify a deliberate-inaccuracy personal liability notice, as confirmed in Bachra v HMRC [2023] UKFTT 91 (TC).

MTIC Fraud: The Supply Chain Problem

Missing Trader Intra-Community (MTIC) fraud exploits the zero-rating of intra-EU supplies of goods. In a typical carousel arrangement, goods (classically mobile phones, computer chips, carbon credits) are imported from an EU supplier free of VAT (zero-rated). A UK importer (the “missing trader”) charges VAT on its UK sale but then disappears without accounting for that VAT to HMRC. The goods pass through one or more “buffer” companies before reaching an “exporter” who zero-rates the supply back to the EU and claims a repayment of the input VAT charged by the last UK supplier in the chain. HMRC suffers the VAT charged by the missing trader but never accounted for.

The question that reaches the courts and tribunals is: what is the VAT position of the innocent (or not so innocent) trader in the middle of the chain, who genuinely purchased goods and paid VAT, but whose supply was connected to the fraudulent evasion?

The Legal Basis for Input Tax Denial

Under sections 24 and 25 VATA 1994 and Articles 167–168 of the Principal VAT Directive (Council Directive 2006/112/EC), a taxable person is entitled to deduct input VAT on goods and services used for the purposes of their taxable supplies. The right to deduct is fundamental to the VAT system. However, the CJEU has developed a principle by which that right is forfeit where the taxpayer is tainted by the fraud of another person in the chain.

The Kittel Principle: CJEU Analysis

The governing authority is the CJEU’s joined judgment in Axel Kittel v Belgium; Belgium v Recolta Recycling SPRL (C-439/04 and C-440/04) [2008] STC 1537. The Court held at paragraphs 45–56 that the right to deduct cannot be exercised by a taxable person who knew or should have known that its purchase was connected with the fraudulent evasion of VAT committed by the vendor or by another trader earlier in the supply chain.

The rationale is that such a taxable person must, for the purposes of the VAT Directives, be regarded as a participant in the fraud, irrespective of whether they themselves profited from the fraudulent scheme. The principle applies whether the fraud was by the direct supplier or by a more remote participant in the chain, provided the knowledge or constructive knowledge condition is satisfied with respect to the particular trader whose right to deduct is in issue.

Knew vs Should Have Known

The Kittel test has two limbs, and their consequences are not identical:

• “Knew” , the trader had actual knowledge that the transaction was connected with fraudulent evasion. This is a subjective finding of fact: what did this trader actually know at the time of the transaction?
• “Should have known” , the trader did not have actual knowledge but, objectively assessed, a reasonable trader exercising due diligence in the same position would have appreciated the connection to fraud. This is constructive knowledge: it does not require dishonesty or a deliberate choice to ignore the fraud.

Both limbs justify denial of the input tax deduction. But, and this is the practitioner’s key point, they do not have the same consequences for penalties and PLNs.

The Reasonable-Steps Protection

The Court in Kittel at paragraph 51 provided the counterweight: traders who take every precaution which could reasonably be required of them to ensure their transactions are not connected with VAT fraud “must be able to rely on the legality of those transactions without the risk of losing the right to deduct the input VAT.” This reasonable-steps protection is the foundation of the due-diligence defence.

What constitutes reasonable steps is fact-specific and has been elaborated in a large body of FTT and UT authority. The following factors are consistently considered:

• VAT registration verification: Did the trader check its counterparties’ VAT registration numbers (through HMRC’s VAT online checker or the EU VIES system)?
• Identity verification: Did the trader obtain and verify company information, directors and registered offices for its counterparties?
• Commercial pricing: Were the prices consistent with genuine commercial supply? Prices significantly above or below market rates are a classic fraud indicator.
• Goods and stock: Did the trader physically inspect the goods? Were they consistent with genuine commercial quantities and specifications?
• Red flags: Were there features of the transaction (back-to-back deals, new counterparties, unusual payment terms, pressure to transact quickly) that a reasonable trader would have investigated?
• Professional advice: Did the trader take advice from accountants or solicitors and act on it?

How HMRC Establishes the Connection

HMRC must prove two things on the assessment appeal: first, that there was fraud in the supply chain (typically a missing trader or hijacked VAT number); and second, that the taxpayer knew or should have known of the connection. In practice:

• The fraud: HMRC will produce evidence of the defaulting trader: failure to submit returns, tax losses, VAT registration issues. HMRC often also establishes the chain of transactions through supplier records, bank records and cross-referencing.
• Knowledge: HMRC uses the objective “should have known” limb most frequently, pointing to red flags the trader ignored, a pattern of trading consistent with fraud participation, the absence of adequate due diligence and pricing.
• Pattern evidence: In cases involving many deals over a period (as in Bachra, which concerned 375 deals across multiple VAT periods), HMRC typically analyses a subset and extrapolates, challenging the trader to disprove the connection.

Bachra v HMRC [2023] UKFTT 91 (TC): Should-Have-Known and the PLN

Bachra v HMRC [2023] UKFTT 91 (TC) is the most important recent authority on the interaction between the Kittel assessment denial and the Schedule 24 personal liability notice. Mrs Bachra was the sole director of OWD Ltd, a Birmingham cash-and-carry business. HMRC denied OWD’s right to deduct input tax of over £2 million on 375 deals in VAT periods 03/14 to 12/16 on the Kittel grounds. OWD’s liquidator withdrew OWD’s appeal against the assessment. HMRC then issued a PLN to Mrs Bachra for the full amount of a deliberate-inaccuracy penalty charged to OWD.

The Tribunal’s Findings

The Tribunal made several important findings:

1. All 375 deals were connected with the fraudulent evasion of VAT (the fraud element of Kittel was established).
2. OWD should have known of that connection, i.e. the constructive knowledge limb was satisfied. This was sufficient to justify the assessment denial.
3. However, OWD did not actually know of the connection. The actual knowledge limb was not satisfied.
4. Consequently, the inaccuracy in OWD’s VAT return was not deliberate. A “should have known” finding is constructive knowledge, not dishonesty or recklessness and does not satisfy the Tooth/Auxilium subjective test for deliberate inaccuracy.
5. Because the penalty condition (deliberate inaccuracy) was not met, the PLN issued to Mrs Bachra could not stand. The Tribunal allowed her appeal in full.

Assessment Denial vs PLN: A Critical Distinction

The practical importance of Bachra is that it cleanly separates two things HMRC frequently conflates: the assessment denial (justified on either limb of Kittel) and the personal liability notice (requiring a deliberate inaccuracy). In a typical case, the following structure applies:

The adviser’s task, where a PLN has been issued alongside a Kittel assessment denial, is to hold HMRC to this distinction. Even where the assessment denial is unwinnable (the taxpayer genuinely should have known), the PLN may still be defeatable if HMRC cannot establish actual knowledge or recklessness on the part of the director.

Burden of Proof: Sintra Global and Beyond

As analysed in our guide on the burden of proof in HMRC penalty appeals, the Court of Appeal in HMRC v Sintra Global [2025] EWCA Civ 1661 confirmed the split-burden rule: HMRC bears the burden of establishing the primary facts for the penalty (including the deliberate inaccuracy and, for a PLN, its attribution to the officer); but if the taxpayer wishes to challenge the underlying liability as a defence to the penalty, a separate legal burden rests on the taxpayer to prove that liability is wrong. In a Kittel PLN case this means:

• HMRC must prove the deliberateness and attribution;
• If the director challenges the underlying VAT assessment (the denial), the legal burden on that challenge rests on the director.

The tactical consequence is that where a company has not appealed (or has had its appeal withdrawn, as in Bachra), the director facing a PLN who also wants to challenge the underlying denial must actively assert and prove that the assessment is wrong, not simply await HMRC to prove it.

Practitioner Strategy

Separate the Assessment from the Penalty from the First Letter

When a Kittel denial and a PLN arrive together, analyse them as distinct proceedings with different tests and different burdens. Do not accept that HMRC winning the assessment challenge (or the company not contesting it) means HMRC automatically wins the PLN.

Build the Due-Diligence Evidence

Assemble everything the company and director did at the time of each deal: VAT verification checks, counterparty due diligence records, commercial pricing research, advice taken. The stronger the due-diligence record, the harder it is to establish either limb of Kittel for the assessment, and the harder it is to establish actual knowledge for the PLN.

Force the Knowing/Should-Have-Known Distinction

Require HMRC to specify, in relation to the PLN, which limb of Kittel it relies on. If HMRC can only establish “should have known,” Bachra is the answer: that is not deliberate. HMRC must particularise the evidence of actual knowledge or recklessness.

Challenge Deal-by-Deal vs Pattern Approach

Where HMRC has sampled deals and extrapolated, challenge both the sample and the extrapolation methodology. The fraud connection must be established for each transaction period whose input tax is denied; and the knowledge/should-have-known finding must be justified for those specific transactions.

Practitioner Checklist

1. Map the supply chain for each tax period: identify the alleged missing trader, buffer companies and the client’s position in the chain.
2. Confirm HMRC’s evidence of the underlying fraud , has HMRC actually established there was a fraudulent evasion, not merely a non-payer?
3. Identify which Kittel limb HMRC relies on , knew or should have known and whether HMRC has evidence for each.
4. Assemble the due-diligence record for each set of transactions: VAT verifications, company checks, pricing, correspondence.
5. Separate the assessment appeal from any penalty/PLN proceedings.
6. Apply Bachra to any PLN: “should have known” is not deliberate. Require HMRC to prove actual knowledge or recklessness attributed to the director.
7. Apply the Sintra Global burden rule: HMRC proves deliberateness; the taxpayer carries any burden of challenging the underlying assessment.
8. Consider the Tooth/Auxilium deliberate-behaviour test , see our guide on the deliberate behaviour test.
9. Check attribution under para 19 Sch 24: even if the company’s inaccuracy were deliberate, is it actually attributable to this director? , see our guide on PLNs for company penalties.

Frequently Asked Questions