Since the introduction of the Domestic Reverse Charge (DRC) for VAT in the UK, HMRC has seen a significant reduction in missing trader VAT fraud in the property and construction sector. However, concerns are growing that fraudsters have simply shifted tactics — and HMRC is now zeroing in on labour supply chains as the next frontier of VAT abuse.
As HMRC intensifies its efforts to tackle VAT fraud, it’s essential to understand what’s happening, what the risks are, and how to protect your business from being caught in a fraudulent supply chain.
In this article, Paul Hammond, Partner at Cowgills gives a quick recap of the DRC, explains why HMRC have now turned their focus on missing VAT in labour supply chains (as well as clamping down on DRC VAT accounting generally) and what you can do to protect your business.
If you need help navigating these risks, contact Paul Hammond, Partner at Cowgills. Paul and his team have extensive experience in HMRC enquiries, VAT disputes, and supply chain risk assessments.
Get in touch at enquiries@cowgills.co.uk
A quick recap – what is the DRC?
The DRC for VAT was introduced on 1 March 2021 to combat VAT fraud in the building and construction sector.
From a (very) high level perspective (and ignoring the specific conditions) the theory is:
- The customer, not the supplier, accounts for the VAT.
- Suppliers do not charge VAT on invoices but must note that the reverse charge applies.
- The customer then records both the output and input VAT on their return.
This prevents the supplier from being able to “go missing” with the VAT without accounting for it to HMRC – the tactic commonly used by fraudsters in missing trader fraud.
The labour supply loophole
The DRC applies to construction services – but not to labour supplied via employment businesses, which are treated as providing staff rather than construction services. Supplies of staff remain under standard VAT rules, meaning suppliers continue to charge and collect VAT as usual.
Fraud has, therefore, migrated away from the construction supply chain and into employment bureaus, labour agencies, and umbrella companies. Fraudulent businesses charge VAT on labour, fail to pay it over to HMRC and disappear – often reappearing under a new name.
HMRC crackdown
HMRC is now scrutinising supply chain integrity in this area, viewing property and construction as a high-risk sector – the sector’s reliance on subcontracting, temporary labour, and cash transactions making it particularly vulnerable.
In the pursuit of cost savings and operational efficiency, property and construction businesses may be tempted to cut corners or overlook warning signs within their supply chains but these actions can lead to serious tax, legal, financial, and reputational consequences.
The risks
The VAT law (through joint and several liability) allows HMRC to action even where you are not directly linked to the fraud. The key risks associated with falling foul of HMRC’s expectations (see below) are:
- Denial of VAT reclaims: Based on the “Kittel” principle, HMRC can deny VAT reclaims if they determine you “knew or should have known” about fraud in your supply chain — even if you weren’t directly involved.
- Financial penalties: Alongside the denial of VAT recovery, significant penalties can be charged – again, regardless of whether the fraud was committed by a third-party supplier.
- Criminal liability: In serious cases, directors, officers, or business owners may face prosecution if they knowingly facilitated fraud—or if their company failed to prevent the facilitation of tax evasion.
HMRC’s expectations
To avoid being implicated in VAT fraud, HMRC expect property and construction businesses to be able to evidence that they have taken reasonable care in selecting and managing suppliers. HMRC expects proactive efforts to validate the integrity of your supply chain.
To this end, you should:
- Vet suppliers and verify documents: Do thorough due diligence. Check backgrounds, references, financials, and ensure proper VAT, PAYE, and NIC registrations are held. Review invoices and contracts for accuracy.
- Monitor VAT invoices and payments: Check VAT numbers regularly, and make note if numbers change – revisit take on processes if bank accounts change.
- Train your staff: Educate your team to spot red flags and understand the risks of VAT fraud. Encourage reporting of suspicious activity.
- Audit and review regularly: Conduct internal reviews of your supply chain, payments, and VAT processes. Identify weaknesses before HMRC does!
- Get expert advice: Work with a tax adviser to review your compliance processes. Consider a supply chain risk assessment to identify areas of vulnerability.
Domestic reverse charge (DRC)
Alongside the above, HMRC are also clamping down on the operation of DRC itself.
Whilst, initially, HMRC applied a “light touch” approach to DRC errors, that period is long gone and HMRC expects full compliance. Mistakes (recovering VAT that should not have been charged) will result in assessments and likely penalties – HMRC do not consider the fact that there may be “no VAT loss” as relevant or a reasonable excuse.
Final thoughts
The DRC has been effective in reducing VAT fraud in the supply of construction services – but fraudsters have adapted and HMRC are wise to this.
The labour supply chain is now firmly in HMRC’s sights, and property development and construction businesses need to ensure that their houses are in order!
If you’re relying on outsourced labour in your projects, it’s essential to understand the VAT implications and ensure your business isn’t unknowingly part of a fraudulent supply chain – the financial, legal, and reputational risks are significant.
If you need expert advice from Paul Hammond and the team get in touch at enquiries@cowgills.co.uk
