VATF72000 - Due diligence and risk assessment: Why a taxable person should undertake due diligence and risk assessment

Taxable persons should not undertake due diligence and risk assessments just to satisfy HMRC but to help ensure that the business is managed effectively and to ensure the integrity of their supply chains. The due diligence and risk assessments should be reasonable and proportionate and demonstrate that the taxable person is managing any risks to his business.

Before entering into a transaction or a particular market, a taxable person should consider the risks associated with that transaction and/or market. This can mean anything from undertaking research on the product/market, researching the supplier(s) and customer(s), entering into written contracts etc. He also needs to take into consideration the way in which the transaction has occurred or is about to occur (VATF60000).

It is important to establish the full details of the due diligence and risk assessment carried out by the taxable person for a number of reasons.

• If other indicators suggest that the transactions were contrived (VATF60000), deficiencies in due diligence / risk assessment may help support a case where we allege that he knew that he was involved in VAT fraud (VATF42700), or that his transactions were connected with fraudulent evasion of VAT (VATF50000), since it may be inferred that the taxable person failed to carry out meaningful due diligence / risk assessment because he knew it was unnecessary, since the transaction(s) had been pre-arranged.
• Equally, in a case involving actual knowledge, the taxable person may present HMRC with pristine due diligence / risk assessment paperwork, in the expectation that this will ensure that his claim to input tax is met. When presented with such paperwork it will be important to test the actual substance and validity of the checks purportedly carried out.
• The mere failure to carry out due diligence / risk assessment will not by itself be sufficient to establish that a taxable person ‘should have known’ he was involved in VAT fraud (VATF53400). However, where we can establish that checks on the taxable person’s suppliers, customers, freight forwarders etc would have given cause for concern, then this will be highly relevant in deciding whether the taxable person ‘should have known’.

In each case, you will be seeking to identify what actions or precautions the taxable person took in response to any indicators of risk. This will focus on due diligence and risk assessment checks undertaken and, most importantly, the actions taken in response to the results of those checks.

Testing the credibility of the due diligence and risk assessment undertaken by the taxable person isn’t just for the purposes of denying input tax using the Kittel principle. Rather, it should be tested to determine whether, in a more general sense, the taxable person knew he was participating in a scheme to defraud the revenue.

Examples of checks that could be carried out by taxable persons set out in paragraph 6.2 of Notice 726, which is itself discussed in VATF73000.