Contractor ignored VAT fraud in supply chain

The construction industry carries a notoriously high risk of VAT fraud and contractors are expected to undertake robust due diligence when engaging suppliers to mitigate this. 

Konstruct Recruitment Limited failed to conduct adequate due diligence into its suppliers, of which five in a row were guilty of VAT evasion. The question for the first tier tribunal (FTT) was whether Konstruct was, or should have been, aware of the fraud in its supply chain – and if yes, was the sole director and shareholder, Rajanbir Singh, responsible? Or was Konstruct the very unfortunate victim of organised fraud?

Konstruct supplied labour to construction companies. It had a small pool of employed workers but also sub-contracted labour from other companies. The appeal related to: 

• denied input VAT reclaims on transactions with two sub-contractors, Combat and Sandhar, totalling £246,124.60
• penalties of £79,237.20 levied against the company, and 
• a personal liability notice (PLN) of £79,237.20 imposed on Singh (VATA 1994 69D). 

It should be made clear at the outset that HMRC did not seek to accuse Konstruct of any fraud, simply that the company and its officer were, or should have been, aware of the existence of fraud within the suppliers, and continued to trade with them regardless.

Warning signs

HMRC first wrote to Konstruct in April 2017 notifying it that one of its suppliers, Flawless Decorators Ltd had been deregistered for VAT. The letter contained a link to HMRC’s leaflet Use of labour providers – advice on due diligence and a strong recommendation that adequate due diligence be applied to new contracts to “minimise the risk of you being connected with any possible subsequent failures”.

Two further letters in August and October 2017 informed Konstruct that another supplier, VG Painting and Decorating Ltd was responsible for tax losses and had been deregistered for VAT. Both letters repeated the strong recommendation regarding due diligence and the link to the leaflet. 

More letters followed and HMRC officers visited Konstruct’s premises twice in 2017. In the second visit, the officers handed Singh another tax loss letter in respect of a supplier, Decon Ltd, and observed that “due diligence checks did not appear to have been carried [out] on VG Contracts and there were minimal due diligence checks on Konstruct’s suppliers Flawless and Decon”. It was also discovered that Konstruct was continuing to trade with VG without questioning why it had been deregistered, nor why it continued to trade above the VAT registration threshold.

The officers reiterated the importance of due diligence and gave Singh a physical copy of the leaflet to use as a guide when engaging with new suppliers. 

The upshot of all this is that by February 2018 Konstruct had been made patently aware both of the general requirement to conduct proper due diligence on its suppliers and, crucially, of the fact that several of its own suppliers were responsible for tax losses. This should have been a clear message that they needed to apply greater scrutiny to their suppliers or risk being penalised for knowingly trading with tax evaders. 

Combat and Sandhar

In February 2018 Konstruct was notified by HMRC that yet another supplier, Combat, had defaulted on its VAT and Construction Industry Scheme (CIS) obligations and in November 2018 tax loss letters were sent in respect of Combat and another supplier, Sandhar. Transactions between Konstruct and these suppliers that had been traced to fraudulent tax losses were itemised in the letters.

HMRC sought to deny Konstruct’s input tax reclaim on several transactions with Combat and Sandhar under Kittel (The European Court of Justice judgment) which says that “taxable persons who ‘knew or should have known’ that the purchases in which input tax was incurred were connected with the fraudulent evasion of VAT will not be entitled to deduct that input tax in certain circumstances”.

Cold callers

According to Konstruct, each of the fraudulent suppliers had cold called the company offering much-needed labour supplies. Due to the urgent need to fulfil contracts – and despite having access to swathes of contacts within the industry – the company accepted these offers without conducting  (in HMRC’s eyes) sufficient checks into the credibility of the suppliers. In giving evidence Singh claimed that he had taken onboard some of the HMRC officers’ recommendations and implemented extra due diligence checks, but no evidence of this was provided.

Indeed much of Singh’s purported due diligence appeared to be based on vibes. In the case of Combat it was stated that Singh “was satisfied that he was engaging with a legitimate business and honest director stating: ‘He appeared to be an upstanding British gentleman.’” While Sandhar won his approval through “being operated in a professional manner and occupying well-equipped offices”.

Turning a blind eye

It was HMRC’s case that Konstruct “deliberately closed its eyes” to the fraud being committed and, despite repeated warnings and extensive recommendations from HMRC, continued to trade with both Combat and Sandhar for months after being notified of the tax losses caused by them. HMRC believed that Konstruct was aware, not only of the risk of fraud within the construction industry, but of the existence of fraud within its supply chain. 

The tax authority added in its submission that it would have been “extraordinarily bad luck if the first appellant, through sheer coincidence, happened to purchase its supply of labour from four successive traders all of whom were responsible for tax loss”.

The FTT had little difficulty in finding for HMRC against both Konstruct and Singh. The judge agreed that it was “more likely than not” that Singh knew about the fraud within the transactions and as the sole director, responsible for running the business and sourcing all labour supply, the actions of Konstruct were his responsibility, so the PLN was upheld.