The move is a bid to address problems with the current approach to ‘knowledge principle’ cases whereby any penalties are issued after the VAT case has been finalised, including litigation.

HMRC says this opens up the opportunity of a second round of litigation, this time against the penalty, adding to costs and delays. The delay increases the risk that, by the time the penalty is issued, it will be ineffective because the monies to pay the penalty may have been dispersed by those involved in the fraud.

The consultation considers a range of options for a new penalty for those that knew or should have known their transactions were connected with VAT fraud. HMRC will be able to levy this penalty at the same time as it takes action to address the primary fraud issue.

HMRC says the key design features are that the new penalty can be issued at the same time as the knowledge principle decision in the underlying VAT fraud case; and does not rely on the distinction between whether a business or individual knew or should have known of the connection with VAT fraud.

The consultation seeks on the merits of the case for introducing such a penalty, as well as comments on its design, for which HMRC is proposing two options.

Option A is a fixed rate penalty of 30% of the VAT due which 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 should have known that its transactions were connected with VAT fraud.

There would be no reduction in the level of the penalty for disclosure of information to HMRC. In addition, the new penalty would also be collectable from company officers such as directors and company secretaries, where the person knew or should have known that the transactions were connected with VAT fraud.

HMRC says this approach means it alone would save around £1m a year in reduced litigation costs. There would be additional internal resource savings of around 500 staff hours a year from HMRC officers.

Option B is  an ‘early payment’ system with a lower 25% rate for cases where the knowledge principle is applied, but with an increase to a 50% penalty when the case is appealed and the outcome is a finding of actual knowledge by the courts.

HMRC says the main advantage is that this option provides for a higher penalty in cases where a business is found by the courts to have actual knowledge that its transactions are connected with VAT fraud. Furthermore, this option would act as a disincentive to businesses that are knowingly involved in the fraud to appeal frivolous cases to tribunal.

Alongside the penalty HMRC invites views on its proposals that it might consider naming and shaming those that participate in VAT fraud.

HMRC is also proposing that that the new penalty regime would not have any reductions in the level of penalty for disclosure of information or cooperation with HMRC. It says this is because its experience indicates that businesses which facilitate VAT fraud rarely make meaningful disclosures, while such an approach would keep the penalty regime simple and provide certainty for businesses and individuals.

In addition, HMRC intends the penalties would apply to company officers, including in instances where they have only been found to be careless i.e. in knowledge principle terms they should have known that their transactions were connected with VAT fraud.

Currently penalties can only be levied on company officers, under Schedule 24, where there’s evidence of deliberate behaviour. In the consultation, HMRC states: ‘Our view is the new penalty will be more effective if it targets company officers. Without this the individuals responsible for the business’s participation in VAT fraud can simply walk away from company liabilities with no personal sanction against them.’

The consultation closes on 11 November.

HMRC’s consultation on Penalty for participating in VAT fraud is here.