VAT: Why supply chain due diligence is vital
Suraj Chauhan and Hilary Oldham, from Chartergate Legal Services, explain why neglecting due diligence when dealing with suppliers could result in HMRC rescinding your VAT registration.
Ingenious Construction Limited (ICL) has failed to reverse HMRC’s decision not to reinstate the company’s VAT registration. The decision is: Ingenious Construction Limited v HMRC  EWHC 2255 (Admin).
ICL supplies construction services. In 2019 HMRC placed ICL on “trader monitoring”, which comprised bi-monthly visits and monthly phone calls from HMRC.
In December 2019, HMRC highlighted to ICL that over a 15-month period, 60 of its transactions commenced with a defaulting trader, resulting in a tax loss exceeding £233,000. HMRC warned the company that its input tax could be denied. HMRC also urged ICL to satisfy itself that it had undertaken sufficient due diligence, commensurate with the perceived risk of the underlying supply chain.
Fraud in the chain
By April 2020, HMRC concluded that ICL was using its VAT registration solely or principally for fraudulent purposes and decided to deregister it for VAT. HMRC also denied ICL’s recovery of input tax for approximately £241,000.
HMRC based its decision on factors including:
- 100% of the labour/payroll services received by ICL in the relevant period were from fraudulent defaulters and the amounts traced back to tax losses;
- there was no evidence of any meaningful due diligence undertaken by ICL on any of their clients or suppliers; and
- ICL had back-to-back transactions with fraudulent defaulters.
ICL appealed to the FTT, citing the serious prejudicial impact of the VAT deregistration. ICL also asked HMRC to restore its VAT registration pending the appeal, which was argued as “disproportionate”.
ICL also submitted an application for hardship in response to the VAT assessments.
In June 2020, HMRC refused to reregister ICL for VAT, maintaining that its decision to deregister ICL on the basis of abuse of the VAT system was correct. HMRC clarified that it was not suggesting that ICL was itself fraudulent, only that it was facilitating fraud.
Role of payroll agents
ICL used around 30 self-employed contractors to undertake work. It contracted out its payroll services to agencies, which would check tradesmen’s CIS status, calculate the payments due and ensure income tax and NIC requirements were met. The agent would pay the tax due to HMRC and ensure compliance with CIS.
ICL alleged that HMRC sought to make an example of it for the purported wrongdoing of some of its contractors, even though HMRC had told the company that it had not been fraudulent. ICL also contended that at an earlier meeting, HMRC stated that ICL’s input tax would not be denied, as it recognised ICL’s legitimacy.
The only checks undertaken by ICL were VAT registration and CIS verification, although it was apparent that payments were made before CIS verification was completed. At the time of deregistration HMRC noted that ICL’s payroll services supplier, Boxvn Limited, had failed to account for VAT and its directors were, coincidentally, responsible for introducing ICL to its previous payroll service suppliers.
HMRC also noted that Boxvn’s director, as ICL’s “agent”, and in the absence of any direct remuneration, had full control of the supply of labour to ICL, without any precautions or risk assessments, except to confirm the above verifications.
There was no evidence of ICL conducting checks of the labour workforce. As such, HMRC opined that ICL simply moved from one fraudulent defaulter to the next. ICL’s directors had awareness of tax fraud in the construction industry, as well as knowledge of the Kittel principle and had been issued with the necessary literature by HMRC on VAT fraud and due diligence.
Lawfulness of deregistration
ICL argued that because HMRC had no power to deregister a person for VAT, it was entitled to be restored to the register and HMRC’s refusal to do so was unlawful.
However, the Court held that:
- HMRC has the power to deregister a person where a VAT number is being used to evade the payment of tax because it is no longer entitled to be registered for VAT;
- the power extends beyond cases where registration is being directly used for fraudulent purposes to where it can be shown that a person’s VAT registration is being used to facilitate fraud and that it knew or should have known of that.
The Court affirmed that it could require HMRC to restore the company to the VAT register temporarily, but only in accordance with the law governing applications for interim relief and applicable additional principles, as follows:
- the public interest in ensuring that HMRC is able to perform the duty of collecting lawfully imposed VAT and that fraud does not infect the VAT system;
- whether by the time the dispute was heard by the tribunal the company would no longer be viable or would have ceased to exist. The Court held that the tribunal appeal would not be rendered ineffective. HMRC’s action was only part of the reason for ICL’s financial ill-health and ultimately, there was no evidence of an imminent risk of business collapse;
- the claimant must demonstrate a realistic chance of success at the tribunal and the unreasonableness of HMRC’s action, plus show there is an abuse of power, impropriety or unfairness.
The Court held that ICL received supplies of tradesmen services from three companies, each of which failed to account for VAT. It was clear that the fraud was to continue with Boxvn. HMRC had acted proportionately, appropriately and on objective factors in deregistering ICL and refusing to restore it to the register.
This case serves as a salutary reminder of the importance of undertaking adequate due diligence to ensure the integrity of the supply chain, and the perils for failing to undertake the same.
ICL should have raised questions about the direct link between the agent and their suppliers and customers. Although ICL was not itself fraudulent, by virtue of its failure to conduct any meaningful due diligence it facilitated fraud. HMRC took measures available to it for holding unassuming businesses to account, including sending warning letters, placing businesses on trader monitoring, VAT assessments and the nuclear option – VAT deregistration.
Whilst for a business it may seem that due diligence is a tedious, and costly, area of administration diminishing the bottom-line return, the position of ICL emphasises the hefty price businesses can pay for failures in undertaking adequate due diligence.
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Suraj Chauhan and Hilary Oldham are VAT consultants at Chartergate Legal Services Ltd. Prior to joining Chartergates, Suraj qualified as a barrister, specialising in VAT, fraud, tax and criminal cases. Hilary is a chartered accountant with a background in business and VAT consultancy.