Fraud in labour supply chains and VAT due diligence

Background and principles

Due diligence in the world of VAT is not a new concept but has been highlighted in a recent HMRC project and is a subject frequently addressed in Tribunal cases.  Our readers will be familiar with some of these cases from our previous newsletters, such as Impact Contracting Solutions (Impact Contracting Solutions v HMRC TC07421), and there is also the 2019 Field Opportunities case (Field Opportunities Ltd v HMRC TC07326) , highlighting the upshot of the ‘Kittel principle’ that the business knew or should have known of fraud within their supply chain and that HMRC can refuse the recovery of input tax on that principle.  These cases are just two of many in this area of VAT.

Has the COVID pandemic pushed HMRC focus on due diligence into the background?

You could be fooled into thinking, that with all the pressures on businesses during the current COVID-19 pandemic, attention to due diligence may have taken something of a back seat.  HMRC are aware that businesses may have many other priorities at present but have given no indication of concession as regards the relaxation of attention to due diligence in supply chain verification.  Indeed, while many tax cases have been put on temporary hold by HMRC during the pandemic, the Fraud Investigation Service (‘FIS’) teams have continued with their project to make enquiries with businesses who are either making or receiving (or both) supplies of labour and to seek to educate the taxpayer in matters pertaining to due diligence on their supply chains.  It is not surprising that HMRC should work to reduce fraud in supply chains when the 2018-19 figures show that 7% of the expected VAT take is not being paid over (in excess of £10 billion).  If anything, that ‘missing’ revenue is an obvious target that is more likely to be hunted down as the Chancellor looks to balance the demanding budgetary position over the coming months.

Scope of due diligence required

Whilst there is an obvious need for due diligence to be relevant, appropriate and adequate, it is part and parcel of business risk management and therefore, due diligence must also be reactive and responsive.  Though there is some limited guidance on due diligence from HMRC (Use of Labour Providers: Advice on Due Diligence and section 6 of VAT Notice 726), unsurprisingly, despite the complicated nature and significant risks involved, there is a lack of specific guidance from HMRC in respect of two key aspects of due diligence:

  • how much due diligence is enough; and
  • how often should due diligence checks be revisited

In truth, HMRC’s general stance on such matters is that it is for individual businesses to determine how much and how often they conduct due diligence – though ultimately, the answers to both questions are purely subjective (whether being determined by businesses, HMRC or the Tribunal).

Risks arising from a lack of VAT due diligence

It is probably helpful at this point to restate the likely risks to a business as regards VAT that would arise from a lack of due diligence being undertaken:

  • a VAT assessment may be raised in circumstances where there has been a failure to remit VAT payable by a supplier to HMRC and a subsequent claim for input tax by the business. Due diligence may be key in challenging the assessment and determining whether it should be overturned.
  • Where the “Kittel Principle” (taxable person knew or should have known that the transaction was connected with the fraudulent evasion of VAT) is engaged, businesses in relevant supply chains may have input tax recovery refused. In this instance, due diligence can provide some evidence as to the relevant business’s knowledge (or lack of) of the fraud in question.
  • Where there is fraud or deliberate tax avoidance, the lack of or inadequate due diligence can potentially lead to criminal proceedings.

Fraud is undoubtedly on the rise in the labour market and forms a large proportion of the sums going missing, mentioned above.  It is highly likely that fraudsters will seek to take advantage of the COVID situation to infiltrate genuine supply chains, hoping that the attentions of both businesses and HMRC are diverted.   HMRC are of the opinion that businesses should not assume that suppliers they have dealt with successfully for many years can be ignored as regards due diligence checks, as those chains are at even greater risk of becoming corrupted by fraudsters because there is over-confidence in their integrity.  This makes it more important that due diligence checks are not just a box ticking exercise done once at the outset of dealing with a supplier.  They need to be thorough and repeated at regular intervals, with the extent of enquiries and the intervals of repetition being set in proportion to perceived risk of the supply being corrupted by fraud.

Is there any payback from better due diligence?

Although for a business it may seem that due diligence is a tedious, and costly, area of administration diminishing the bottom line return, in fact it is more akin to taking out an insurance policy to protect against potential costs that could not be borne.  In addition to the potential cost of a refusal of input tax recovery, the management time taken up by an HMRC enquiry should not be taken lightly and as HMRC have a stated intention to visit (whether physically or by conference call) as many businesses as possible who are involved in supplies of labour, it is reasonable to expect they will open more enquiries over the coming year.  With a robust due diligence policy in place and well-recorded results of due diligence questionnaires and action taken in response to any warning signals arising from those results, it is possible that what may have become a very time-consuming enquiry from HMRC can be cut back to a much simpler review.  We have noted that the FIS teams in the field have due diligence as a key focus in their work.

How can Chartergates help?

At Chartergates, we can provide you with complete assistance to help you comply with your due diligence requirements. Thus, with regards to due diligence, our services include:

  • Review of your current due diligence practices, procedures and policies.
  • Drafting an internal due diligence policy
  • Drafting a Supplier Due Diligence Questionnaire
  • Drafting a Risk Analysis Guide
  • Conducting Due Diligence Audits
  • Reviewing Due Diligence conducted by your business

Further Advice

For further advice or information on VAT Due Diligence, including how Chartergates can assist your business in complying with the necessary due diligence requirements, or queries of VAT matters generally, please contact the Chartergates Team.

Published: 09.14.20 - Posted In: Latest News,VAT News