Tax Shake-Up to Fight Missing Trader Fraud

Missing trader fraud

The fraud typically occurs when the supplier of the relevant construction services recovers VAT due from its customer but then fails to account for that VAT to HM Revenue & Customs (HMRC). Instead, the supplier keeps the VAT and then disappears, leaving HMRC out of pocket.

HMRC has already tackled fraud concerning direct tax in the construction industry with the Construction Industry Scheme (CIS). The CIS put the payer in the position of the tax collector to make sure that those sub-contractors not vetted by HMRC suffer tax at source and do not receive gross payments for construction services.

Treasury proposals

The Treasury’s proposal to tackle this VAT fraud is to introduce a reverse charge mechanism. This mechanism has already been used to tackle other VAT frauds concerning things such as mobile phones and computer chips. The reverse charge mechanism is similar to the CIS in that it makes the recipient of the relevant supply (i.e. the customer) the tax collector. The customer will have to charge itself VAT and then seek to recover this from HMRC through its relevant VAT return (see Example). This proposal will prevent those suppliers that would otherwise go missing with the relevant VAT from ever receiving it in the first instance. For the customer having to charge itself VAT, if it can fully recover such VAT, the reverse charge will have no net financial impact – but it will create a significant administrative burden.

HMRC is of the view that the risk of fraud in the construction industry is principally centred on the supply of construction services between businesses in the supply chain and, therefore, the proposals will only cover sums paid by construction businesses to other construction businesses. Construction services supplied to those not in the construction business will be subject to VAT in the normal manner.

The reverse charge will only apply to certain types of construction services (which unlike the CIS, will include goods that are supplied with those services).

The definition of “construction services” is very wide and is taken from that applicable to the CIS. Such services can include painting and decorating, the installation of heating and lighting systems, internal cleaning as well as general construction and demolition works.

Example

Retailer A engages company B to refurbish one of its stores and pays company B £60,000 plus VAT (£12,000) for its construction services.

Company B engages company C to undertake some of the construction works the cost of which is £30,000 plus VAT (£6,000).

Assume company B and company C are VAT registered and that company B recovers from HMRC all VAT incurred by it.

Retailer A will pay VAT charged to it (£12,000) by company B.

Company B will have account to HMRC for such VAT received from retailer A. Company B will therefore be in a net neutral VAT position.

As regards supplies made by company C to company B, no VAT should be charged by company C to company B and, if VAT is charged by company C, company B should refuse to pay it. Company B will charge itself VAT (of £6,000) in respect of the supplies made to it by company C and company B should be able to recover this VAT from HMRC. Company B will need to pay the net amount to company C namely £30,000 but company C never receives any VAT from company B and so cannot abscond with it.

The reverse charge does not apply to zero-rated supplies of construction services.

There is no threshold to the applicability of the reverse charge; it will apply regardless of the value of the supply and the size of the business.

There are some proposed exceptions to the reverse charge for supplies of services where the supplier and the customer are connected in a specified manner.

The reverse charge will give rise to increased administration for businesses. Customers (instead of suppliers) will become responsible for determining the VAT-able status of construction services supplied to them and suppliers of construction services will need to check precisely who their supply is to – because if not another construction business, they will need to collect VAT on their supplies or risk being out of pocket.

This measure is expected to impact on around 100,000-150,000 businesses in the construction industry and needs to be thought about now.

Introduction date

The Treasury is currently conducting a technical consultation on the draft legislation for the reverse charge with the final version of this being published in October 2018. The reverse charge itself isn’t intended to come into effect until 1 October 2019. The delayed introduction of these proposals stems from the Treasury’s recognition that they will require significant change for many businesses. The Treasury hopes the long lead-in time will give those businesses the time they need to implement the necessary procedures to correctly operate the reverse charge.

Key points

• Look at the draft legislation when it is published later this year.
• Check how (if at all) the proposals apply to you, either in respect of supplies provided by you, or supplies provided to you.
• Consider what procedures you need to implement to correctly operate the new proposals.
• Speak to your professional advisers if you are unclear how the proposals will work.