VAT fraud in the construction sector – are you at risk?

HMRC are utilising all of their powers when it comes to combatting VAT fraud in the Construction sector, and we are seeing increased activity and HMRC scrutiny when it comes to businesses receiving labour supplies.

HMRC Powers

It can be difficult for HMRC to enforce action on a supplier committing missing trader fraud (the type of fraud where the supplier evades some or all of the VAT due to HMRC), so HMRC have been given powers to take action on those businesses operating within the supply chain. These are:

1. Denial of input tax recovery if the claimant ‘knew or should have known’ that the transaction was connected with fraud;
2. Cancellation of VAT registration if a VAT registration is used for the purposes of VAT evasion, e.g. to recover as input tax VAT incurred on a fraudulent transaction; and
3. Holding customers jointly and severally liable for the output tax which should have been paid by the defaulting supplier, if the customer knew or had reasonable grounds to suspect that the VAT would go unpaid.

Denying input tax (a) is the most common area of enforcement by HMRC.

You may know that HMRC expect businesses to take ‘reasonable steps’ to verify the legitimacy of their suppliers and customers.  Businesses cannot blindly recover VAT on invoices, there must be some checks undertaken (is it a VAT invoice, is the VAT properly chargeable, is the VAT number valid, etc).  However, in some particularly high-risk sectors, HMRC will expect much more diligence on suppliers, and failure to complete satisfactory due diligence can lead to HMRC utilising its powers and blocking input tax where fraud has been committed in the supply chain.

In Regent Commodities v HMRC the Upper Tribunal (UT) recently said that “a person with actual knowledge that his transactions were connected with VAT evasion can lose the right to recover input tax however extensive his due diligence”.

Therefore, accepting invoices from suppliers where there is known fraud in the supply chain could put the input VAT at risk of challenge from HMRC, and leave you out of pocket.

What proof does HMRC need?

A claimant loses the right to recover certain input tax if, on the balance of probability, HMRC can prove:

1. there was a VAT loss;
2. that loss resulted from a fraudulent evasion (the question is whether someone fraudulently evaded VAT, not whether the claimant was fraudulent);
3. the claimant’s relevant transactions were ‘connected’ to such evasion. The requisite connection can be proved even if the claimant did not deal with or know the fraudster, i.e. a connection through a chain of transactions or through some arrangement can be enough; and
4. the claimant knew or should have known that its purchases were connected to such evasion. This is an objective test which is not determined by what the claimant, viewed subjectively, actually knew or by assurances given to it by other persons.

Protect your position!

Businesses receiving supplies of labour are potentially at risk of being in a fraudulent supply chain on two fronts, firstly that the labour provider is evading VAT, and secondly, if the fraud is linked to umbrella companies.

Businesses operating within the sector are recommended to undertake supplier due diligence on all of their labour suppliers.  HMRC guidance states that these checks should be ‘risk based’, so if any of the checks return information that causes concern, you should perform additional checks to satisfy yourself that your position is protected from challenge from HMRC.  There is a list of things to consider below.

If any supplier fails the checks or gives you any reason that casts doubt on the integrity of the business, we recommend that you cease to trade with that entity until they are able to provide satisfactory evidence.

You should keep detailed files showing the checks undertaken, and re-do checks periodically, to understand the risk factor of each supplier.

Don’t underestimate your risk

Even if you are able to implement a robust system of checks, HMRC may still decide to take action against the company.

It is imperative that you are able to demonstrate that due diligence has been undertaken, as set out in HMRC’s guidance, and be able to demonstrate that all reasonable steps were taken to identify fraud. You should also retain evidence that documents there is no way you ‘could have known’ there was fraud in the supply chain.

What checks could you make?

• Company Checks – You are looking to establish the legitimacy of the company
• Request company number and registered office – check these against Companies House.  Do the addresses match VAT registration and other documentary information held?
• Look at the list of Directors and see if these change frequently, or have changed recently.
• Has the company name changed? What from? Is it something unconnected? i.e. have they bought a company “off the shelf” or taken over an unconnected company? What is the reason for that?
• Are the accounts and records up to date?

• VAT Registration
• Request a copy of the VAT certificate – check addresses, business names, SIC codes, etc.
• If the name or address is different from Companies House – ask why?
• Do the details match VAT invoices provided?
• Contact HMRC and validate the VAT number – keep copies of correspondence.
• Ask for a copy of the VAT account – do the figures look reasonable? Do they owe HMRC any money?

• Bank Details
• Request a bank statement (or at least the name, address and confirmation of the bank details)
• Check the name on the account and does it match what you’ve been provided with
• Is it an overseas account?
• Does the address match those on Companies house and VAT registration?

• Identity Checks
• Request ID from the Directors to verify identity
• If your contact is someone other than a company official, what is the reason for that?
• How do you correspond with suppliers? Is it the same contact each time? Do you speak on the phone or only via email, or similar where it is easy to impersonate that individual?

What to do if you are challenged

HMRC will usually start with either a compliance check, or a ‘pre-assessment’ letter to notify the business that there has been fraud in the supply chain.  It’s important to read any documentation carefully, is there a call to action.

Your adviser can be present at any visits, and having an independent third party present can be helpful as the VAT at stake can be significant and these visits can be overwhelming, and your adviser can be objective.

Have a list of questions prepared, and take detailed notes – what questions were asked and what responses were given? Request copies of notes taken by HMRC and notify them of inconsistencies or errors immediately (HMRC officers are human too!).

We recommend that you comply with all HMRC requests for information.  This can be a frustrating process and a significant volume of information can be requested, but willingness to comply will be in your favour.

We also recommend that you get your adviser involved as soon as practicable.  HMRC are required to adhere to certain procedures and processes that your adviser will be familiar with.

If you’d like to learn more, get in touch with our expert team today.