VAT risk in Labour Supply Chains

HMRC are targeting poor compliance in labour supply chains. Amongst other sectors, this is impacting the construction sector, where withheld VAT repayments can have massive impact on cashflow.

Whilst there is a need to ensure that everyone in the supply chain is paying their legitimate tax liabilities and complying with labour regulations, action by HMRC can mean that legitimate businesses are unwittingly caught out by tainted chains and significantly impacted by enforcement action.

Earlier this year HMRC issued updated guidance on Labour Supply Chain Assurance. The guidance sets out the minimum compliance standards which HMRC expect to see during their enforcement activities to demonstrate that businesses have taken reasonable care that their suppliers are acting legitimately. To ensure that records are robust enough to quickly refute any challenge from HMRC, anyone buying in agency labour should be aware of the requirements to check the compliance of suppliers, through the full length of the supply chain.

In an effort to remove non-compliant businesses from the supply chain, HMRC have been challenging VAT recovery of construction companies if they believe that those business should have known that another business in their supply chain is not operating legitimately.

A construction company hires in workers from a specialist labour provider. The labour provider is responsible for operating PAYE and all payroll deductions, making sure National Minimum Wage regulations are complied with and ensuring employees have the right to work. Each week, the Labour Provider sends an invoice to the construction company for their charges plus VAT.

In line with many construction businesses, the company is usually in a repayment position, getting VAT refunds on each return, largely due to the VAT paid to labour providers. It submits its monthly return, and plans cashflow around the date it normally expects to receive the VAT repayment.

HMRC withholds the repayment, asking instead to see evidence that the construction company has undertaken supply chain due diligence. The letter from HMRC may state that businesses which the construction company does not directly deal with have been non-compliant and therefore, the input tax claimed by the construction company will not be repaid. Only if the business is able to demonstrate that it has taken reasonable care to check that its supplier is compliant will HMRC release the repayment.

Information which they will expect to be available includes, evidence that, each time a payment is made to the labour provider, the construction company is satisfied that that business is complying with its tax and employment obligations. To speed up HMRC checks, it is important to not only undertake the checks, but retain records to quickly show that the checks have returned satisfactory results.

HMRC’s advice on the checks to undertake is given in the attached guidance. Checks must be done at the contracting stage, and reviewed at regular intervals. No set guidance is given on how frequently that should be done, but one very simple check would be to verify that a supplier’s VAT number is still valid each time payment is processed. HMRC deregister businesses from VAT is they believe that there is a risk of a loss of tax to the revenue. If you pay a supplier who has been deregistered, you may not be permitted to recover that VAT as input tax.

Compliance action by HMRC can be triggered by events outside of the control of the business, but can have catastrophic impact on cashflows and involve many hours of work to retrospectively gather together proof that reasonable care has been taken. Ensuring that robust checks are taken on a regular basis and keeping evidence to quickly demonstrate that reasonable care has been taken can ensure any such action by HMRC can be quickly resolved.