VAT fraud in labour supply chains

A form of VAT fraud has become a serious problem in labour supply chains. Agencies and their clients can find themselves forced to bear liability for the stolen VAT and large penalties, even when they did not know they were participating in transactions connected with the fraudulent evasion of VAT. It is enough that they “should have known”.

Labour supply chains have become targets for as it is normal for large amounts of VAT to flow through them. The fraudsters insert themselves into a labour supply chain in such a way that the VAT will flow through them so they can steal it rather than account for it to HMRC. Once the fraud is discovered, the fraudster disappears (goes “missing” in HMRC parlance).

The fraud can be extremely lucrative. It is not unusual to find that millions of pounds have been stolen before the fraud was discovered. For this reason, the fraudsters are prepared to go to great lengths to find ways into labour supply chains and are always looking for more opportunities. For example, a fraudster may set up and operate a fully functional payroll service provider and for months, or even years, faithfully handle payments to the workers and account to HMRC for PAYE and NIC whilst stealing the VAT. They will do all they can to present themselves as legitimate participants in a labour supply chain and hide what they are doing. Shell companies, fake or hijacked identities, fake LinkedIn profiles, fake client testimonies, hijacked VAT numbers and so on are all tools of the criminals’ trade.

Typically, a legitimate business is horrified to find that they have been involved in labour supply chains exploited by criminals and hopes that HMRC will find them and bring them to justice. It usually comes as a shock to find that HMRC may seek to hold them liable for the stolen VAT. For good measure, HMRC might also threaten to impose penalties and deregister them for VAT, effectively putting them out of business.

What action does HMRC take?

HMRC can deny a business the right to claim back VAT if the business knew or should have known it was involved in transactions linked to VAT fraud. The rationale for this is that the fraudsters cannot steal the VAT without trading with legitimate businesses and so the law expects those legitimate businesses to take care to avoid trading with criminals. Where HMRC discovers that VAT has been stolen, it will look along the labour supply chain and seek to deny the related input VAT reclaimed by legitimate businesses.

These are two recent real-world examples of businesses finding themselves in that awful position:

1. In Opus Labour Services Limited, the employment agency had purchased payroll services from five companies. Ultimately Opus had to concede that all the payroll companies fraudulently failed to account to HMRC for the VAT which they had invoiced to Opus or, having subcontracted the provision of the payroll services, the sub-contractor fraudulently failed to account for the relevant VAT. Opus was left to argue that it did not know and could not have known it was participating in transactions connected with the fraudulent evasion of VAT. The Tribunal found that Opus did not know that it was doing that, but that it should have known. As a result, Opus was left to bear liability for roughly £1.7m of VAT and penalties of about £469,000. Furthermore, the director of Opus has been left facing “personal liability notices” issued by HMRC in respect of all the penalties.
2. In Red Rose Payroll Limited (“RRP”), the Appellant was an experienced and legitimate payroll service provider. RRP was asked to provide outsourced payroll bureau services to a number of other companies involved with Construction Industry Scheme workers. Other companies in the labour supply chains fraudulently failed to account for VAT. HMRC then denied RRP its entitlement to claim input VAT amounting to more than £7m. HMRC also imposed a penalty of about £2.2m and deregistered RRP for VAT. Following a five-day Tribunal hearing more than three years later, RRP succeeded in convincing the Tribunal that HMRC had not discharged the burden of proving that RRP either knew or should have known it was participating in transactions connected with the fraudulent evasion of VAT.

What can businesses do to protect themselves?

HMRC has published detailed general guidance about due diligence it expects business to do when they are involved in labour supply chains.

Much of this is directed at a range of other risks, but aspects are aimed at finding signs of VAT fraud. Certainly, HMRC will argue that a reasonable business will have followed this guidance and learned all the information that doing so would have uncovered. It is important to recognise that it is not necessary that full details of the fraud would have been revealed; it is enough that a reasonable business, armed with the fragments of information uncovered, would have concluded that a transaction was connected with the fraudulent evasion of VAT.

Also, it is expected that if potential warning signs are discovered, a business will dig deeper to see if it can find more information. As such, there is not checklist to follow, and a business will be judged on the basis of everything it could have discovered if it had made the enquiries a reasonable business would have made.

A business should not assume that HMRC will quickly spot this sort of VAT fraud, as it is extremely hard to spot. When it does, the fraud has often been running for many months, and the fraudster will have been preparing to “go missing” at that moment from the start.

Ultimately, a business involved in a labour supply chain which sees them paying VAT to another party is at risk and needs to take an interest in what is happening to the VAT in the chain. Businesses should be asking:

• Is there a legitimate reason for that party to be involved in the chain and receive the VAT?
• What is happening to the VAT? Is the recipient accounting for it to HMRC or are they paying it to another party?
• Are they being asked by a supplier to make payments to a third party?
• What is the reason for any change in the supply chain, and does it affect how the VAT passes through the chain?

If a business is unsure what to check or what to make of what it finds, it should seek advice.

A particular challenge arises when a business receives a letter or visit from HMRC which suggests that HMRC has concerns about fraud in its supply chains. HMRC might provide little detail; sometimes the taxpayer confidentiality obligations it owes prevent it from sharing information it has about others. Any business which ignores such warnings is inviting trouble if later HMRC does say fraud has occurred – the argument will always be that a reasonable business would have responded to such warnings. Indeed, if HMRC just makes contact with a business to ask for information about its labour supply chains, that should be taken as warning sign of potential trouble, and it should seek advice.

If you have questions or concerns about VAT fraud, please contact tax lawyer Matheu Smith.