DD Series: Labour Supply Chain Compliance – VAT Fraud

We examine HMRC’s approach to investigations where it considers that labour supplies are connected with fraud and the preventative measures which should be adopted.    

Over the past few months, we have seen a number of “nudge” type letters sent from HMRC’s Fraud Investigation Service (FIS) to construction companies and temporary work agencies warning of potential risks associated with supply chain fraud.    

We have set out below a typical example of a letter which has been issued by HMRC. 

/Content/files/5e86-191114 Supply chain letter.pdf

The letter will either contain a request for a meeting or, in the alternative, a warning that the sector in which the recipient trades, is susceptible to supply chain fraud.

It is important that these letters are not ignored for the reasons which we will now explore.

HMRC has long since held the belief that extended supply chains constitute an unacceptable risk to the Exchequer and has attempted to curtail tax leakage by introducing various measures in an attempt to encourage what it considers to be compliance with tax legislation.  

Over the past few years, the Government has taken steps to counteract what it considers to be unacceptable behaviours by introducing new legislation relating to the following; 

• Travel and associated subsistence expenditure.
• Off-payroll working
• Flat Rate VAT Scheme with the introduction of a new rate for “limited cost traders”.       

In keeping with its new preventative strategy, HMRC has turned its attention to labour users and temporary work agencies which are considered to have failed to take appropriate measures when using third-party intermediary structures which involve extended supply chains.

In an attempt to encourage compliance, HMRC is adopting an approach usually seen in Missing Trader VAT Fraud cases (MTIC) where a fraudulent supplier sells goods to a customer plus VAT, the customer recovers VAT from HMRC and the supplier disappears without paying the VAT over to HMRC.

In labour supply arrangements, although no “goods” are present, HMRC is using the same case-law to disallow input tax recovery by labour users who purchase labour supplies without undertaking sufficient precautions to satisfy themselves that the supplies are genuine and do not involve VAT fraud. This is often referred to the “knew or should have known” test or Kittel Principle which is derived from a Belgian case heard in 2008.

It is worth mentioning that in order to deny recovery of the input tax, HMRC would have to;

1. Prove that a VAT loss had occurred and,
2. The loss arose from fraudulent evasion.

In terms of precautions, sufficient due diligence must be undertaken on all labour suppliers if a challenge from HMRC is to be successfully defended.  Unfortunately, HMRC will not be drawn on the extent of the precautions which are necessary citing that every case will be treated on its merits.  

It is certainly too early to judge the success of this approach from HMRC’s perspective and future case-law will determine what is acceptable in terms of due diligence when managing a labour supply chain as opposed to a supplier of goods.

Aspire has recently been in discussions with HMRC’s Fraud Investigation Service (FIS) to establish what would be considered as acceptable due diligence.

As a consequence of these discussions, we have produced an approach to due diligence which, if adopted in its entirety, can be used to resist any attack under the “known or should have known” test.

Our approach consists of the following;

• Supply Chain Management Programme
• Due Diligence Policy
• Ongoing Management Review Process

We have also developed a training course designed to explain the due diligence approach which also incorporates a risk awareness session. 

Should you wish to discuss any of the points raised in this article, please contact us on 0121 445 6178 or enquire@aspirepartnership.co.uk.