In Cheema Constructions Services Ltd & Anor v HMRC [2025] TC09418, the First Tier Tribunal (FTT) found that the Kittel Principle did not apply, meaning the company was entitled to reclaim input VAT.
Cheema Construction Services Ltd (CCSL) operated in the construction sector, with its main activities being the construction of roads and motorways. It did not have any employed workers but hired them from other labour suppliers as needed and, in turn, supplied this labour to its customers.
- The transactions in question related to the supply of labour that CCSL received from Woodside Contracts Ltd (Woodside).
- HMRC refused CCSL’s claim to Recover input VAT incurred on the Purchase of labour from Woodside as having undertaken an extended verification of the relevant transactions, HMRC were satisfied that those transactions resulted from the fraudulent evasion of VAT and that CCSL knew, or should have known, that this was the case.
- HMRC also issued Penalties to CCSL and its director, Mr Cheema, under sections 69C and 69D VATA 1994 (Penalties for transactions connected with fraud).
- CCSL and Mr Cheema Appealed to the First Tier Tribunal (FTT).
The FTT did not consider whether or not the transactions resulted from fraudulent VAT evasion but instead considered the Kittel Principle test.
- The Kittel test was laid down in a Court of Justice of the European Communities (CJEU) ruling (Kittel) and considered in further UK Upper Tribunal and Court of Appeal cases.
- Under the Kittel Principle, the right to deduct input tax will is lost where a taxable person “knew or should have known” that the transaction was connected with the fraudulent evasion of VAT. This is because the person is aiding the fraud perpetrators.
- A person is considered to “know or should know” if they deliberately choose to ignore facts or knowledge that they would prefer not to know. Such knowledge has been described as 'Nelsonian' or 'blind-eye' knowledge, after Nelson, who at the battle of Copenhagen made a deliberate decision to place the telescope to his blind eye in order to avoid seeing what he knew he would see if he placed it to his good eye. For the Kittel test, Nelsonian knowledge approximates to knowledge.
Where HMRC rely on the Kittel Principle, they must prove that each element of the test set down by the CJEU is satisfied, namely:
- There was fraudulent evasion of VAT.
- CCSL’s purchases on which input tax had been denied were connected with that fraudulent evasion of VAT.
- CCSL knew or should have known that its purchases were connected with the fraudulent evasion of VAT.
Tests 2 and 3 were considered by the FTT.
Test 2
- In support of their case for Test 2, HMRC argued that all of the workers on CCSL’s sites sourced from Woodside had been provided to Woodside from fraudulent VAT and Construction Industry Scheme (CIS) defaulters.
- This assertion was based on CIS returns, submitted by Woodside for the periods in question, which only showed subcontractors who were fraudulent VAT and CIS defaulters.
- CCSL argued that they had no reason to believe that the workers obtained from Woodside were engaged by Woodside from the fraudulent VAT and CIS defaulters. CCSL knew that Woodside had its own employees.
The FTT found:
- HMRC failed to satisfy the burden of proof for Test 2.
- CCSL could have received supplies of workers that were supplied to Woodside by the fraudulent VAT and CIS defaulters or they could have received supplies of workers that were employees of Woodside or self-employed contractors who Woodside erroneously omitted from its CIS returns.
- HMRC was unable to prove that CCSL’s purchases on which input tax had been denied were connected with that fraudulent evasion of VAT.
Test 3
- Whilst it was unnecessary, given the above finding that HMRC were unable to prove the second Kittel Principle test, the FTT did consider the third test.
It was found that:
- 'Dereg Veto letters', advising CCSL that numerous suppliers of labour to Woodside were fraudulent, and containing guidance on supply chain due diligence, were sent to CCSL in 2011-12. The VAT periods in question were at least four years later. This time difference limited the extent to which Mr Cheema would have been aware of the potential of VAT fraud.
- The fact that Mr Cheema would have been aware there was VAT fraud in the industry cannot in itself lead to the conclusion that the supplies from Woodside were connected with fraud since there was also a legitimate market in addition to the fraudulent one.
- The FTT accepted that parts of due diligence may have been lax, but HMRC did not show, on the balance of probabilities, that the due diligence conducted established actual knowledge.
- HMRC did not establish that even had other (reasonable) due diligence checks been done, CCSL would/should have concluded that the only reasonable explanation for Woodside’s supplies was a connection to the fraudulent evasion of VAT.
- In 2021, a Dereg Veto letter was sent to CCSL, advising that Woodside had been deregistered for VAT, with the letter referencing “increasing problems with fraud and unpaid taxes with businesses that act as labour providers”. The letter contained a link to HMRC’s guidance 'Use of Labour Providers – Advice on due diligence'.
- In spite of this, CCSL continued to make payments to Woodside for a further three months.
- The FTT found that it was more likely that Mr Cheema simply wanted to complete the project with staff already established on the site and understood the deregistration related to VAT and so he did not pay VAT to Woodside, to ensure that there was no VAT loss.
The appeal was allowed.
Editor’s comment
In this case, the third Kittel Principle test, “knew or should have known” was not necessary, because HMRC were unable to prove Test 2 (that the appellant’s transactions were part of fraudulent supply chains).
If the result of the case had hinged on Test 3, HMRC may have responded differently and argued that the appellant had 'Nelsonian knowledge', which could have resulted in a better result for them.
Supply chain VAT and CIS fraud remains an area of focus for HMRC, so rigorous due diligence procedures are necessary.
Useful guides on this topic
VAT fraud: What is the Kittel principle?
What is the VAT Kittel principle? What happens when the Kittel principle applies? What tests do HMRC and the tribunals apply? How can I protect my business?
Input VAT: What constitutes a valid claim (& VAT invoice)?
What is Input VAT? Who can claim it? What is needed for a valid claim? What needs to be included on a VAT invoice and can you make a claim without one?
Staff, Bureaux or Agencies and VAT
What are the VAT issues when an employer supplies services to an employee or vice versa?
CIS: Contractors and Subcontractors
What is the Construction Industry Scheme? Who does it apply to? How does it work?
Appeals: VAT
How do I appeal a VAT penalty? How can I request a Statutory Review? How do I appeal an HMRC decision?
Penalties (VAT)
When do penalties apply for VAT? What penalties are charged and how can they be mitigated?
External link
Cheema Constructions Services Ltd & Anor v HMRC [2025] TC09418
