Don’t rely on the VAT Domestic Reverse Charge in Construction to eradicate VAT fraud

10 February 2021

Don’t rely on the VAT Domestic Reverse Charge in Construction to eradicate VAT fraud

Rhian Lloyd blogs on the continued risk of fraud in construction supply chains, despite the introduction of the VAT Domestic Reverse Charge (DRC).

Assuming the DRC in construction does take effect on 1 March 2021 as intended – will it be third time lucky? - it is important that construction contractors do not breathe a sigh of relief that it will be the end of VAT fraud in its supply chains.

Yes, it should mitigate VAT losses throughout the supply chain for HMRC on the basis that the customers will be paying over the VAT due to HMRC on behalf of their subcontractors (similarly to paying tax to HMRC for the net status CIS subcontractors) however, be cautious that…

         1.  The DRC doesn’t apply to the supply of staff…

The DRC only applies to supplies of construction services caught by the scope of the CIS. The supply of staff by employment businesses will not.

Confusingly, HMRC first gave the message “if CIS applies, the DRC applies”. However, it is not so clear-cut when it comes to subcontractors in the form of agencies and contracting intermediaries. Yes, you will continue to verify these entities under CIS because they fall within the scope of CIS, but so long as they are supplying staff and not a construction service, the DRC will not apply. See our previous news here.

In this regard, it is imperative that construction contractors take steps to protect the risk of VAT fraud in their supply chains if they engage agencies and/or contracting intermediaries which make a supply of staff.

HMRC are heavily targeting construction temporary labour supply chains (see our previous news item here) so take action.

        2.  On this basis, subcontractors may ‘reinvent’ themselves…

Subcontractors are likely to suffer cashflow issues due to the introduction of the DRC on the basis that they will no longer receive the VAT element of their invoices. Many may become “repayment traders” (i.e. they have input tax to claim on purchases but no output tax due on sales) and so, are recommended to apply to submit monthly VAT returns to HMRC, as opposed to quarterly.

Due to the financial disadvantages suffered by subcontractors, on top of an already turbulent period of trade due to COVID-19, there is the possibility that ‘rogue’ subcontractors may try to reinvent themselves as employment businesses supplying staff in order for the DRC not to apply, meaning they will still receive their VAT payments and, hey presto, the cash flow issues are gone.

We recommend that you ensure you are comfortable with and have full understanding of the following;

  1. The difference between a supply of staff by an employment business versus the supply of labour as a construction service by a subcontractor.
  2. Your contractual arrangements differing between the two supplies at (1).
  3. Due diligence on labour providers.
  4. The critical consequences of not undertaking sufficient due diligence.

If these issues raise any questions or queries please do not hesitate to contact me (0121 445 6178).