Tax risks
Provides an overview of the tax risks that HMRC finds when labour is engaged through a supply chain.
This section outlines the main tax risks that HMRC sees when working with non-compliance in labour supply chains.
As an end user or provider of workers, or services which include labour, understanding how they are engaged and paid in your labour supply chains helps protect your business from exposure to risks.
Models of engagement are more likely to either carry risk or mean that you have responsibilities under certain rules.
For example, those engaged through umbrella companies may present more risk. Those working through their own personal service company will require you to operate the off-payroll working rules.
A worker’s employment status will determine who is responsible for working out the Income Tax and employee National Insurance contributions due, deducting it correctly and paying it to HMRC. This includes employer National Insurance contributions and the apprenticeship levy.
Considerations include:
-
the off-payroll working rules legislation may apply
- agency legislation may apply for employment intermediaries
- managed service company legislation may apply
- engagement through umbrella companies can affect where the responsibility sits for making calculations and deductions
- whether offshore intermediaries are involved
Where you sit in a labour supply chain can play a part in determining your responsibility for applying employment status decisions correctly and getting Income Tax and National Insurance contributions treatment right. This also affects the potential implications you could face.
As a larger business in a labour supply chain, you could be:
- an end-user and client
- a deemed employer under off-payroll working rules
- an employment intermediary — including an agency
- a combination — for example, you could be an agency and a deemed employer within the off-payroll working rules
A workers employment status can also interact with other tax treatment decisions you might need to make, such as those relating to the Construction Industry Scheme (CIS).
Off-payroll working rules (commonly known as IR35) mean that as an end-client, for tax purposes you will need to decide the employment status of workers who provide their services to you through their own intermediary. This is often their own limited company known as a personal service company. This is the case even if they are provided through an agency. These rules apply to a client of any size in the public sector, and a medium or large client in the private sector.
You may be responsible for any unpaid Income Tax, National Insurance contributions and apprenticeship levy if you have engaged a worker providing their services through their own intermediary and you have not correctly applied the off-payroll working rules. You may also become responsible for unpaid amounts if another party in the contractual chain fails to operate the rules correctly and HMRC cannot recover these amounts from them.
A worker’s employment status can also interact with other tax treatment decisions you may need to make, such as those relating to the CIS.
Read the Guidelines for Compliance product Help to comply with reformed off-payroll working rules (IR35) for further information.
Where workers are engaged as individuals or are operating through their own intermediary, the off-payroll working rules (IR35) should be considered before CIS status is determined and their employment status should be included on monthly CIS returns.
A sub-contractor’s CIS status can change and this needs to be verified to make sure payments and deductions are made correctly, as they contribute towards the workers Income Tax and National Insurance contributions liability.
Risks include:
- contractors making gross payments incorrectly (if the sub-contractor loses gross payment status (GPS))
- incorrect deductions being made
- payments not being made to HMRC
- the worker’s Income Tax and National Insurance contributions may not be covered
A contractors own tax position can be affected if they make gross payments incorrectly to sub-contractors. This can include losing their own GPS.
Self-billing arrangements require a written agreement between a customer and each supplier operating this arrangement. Invoices will be considered invalid for VAT where a supplier’s VAT registration status has changed and the guidance for reviewing and updating self-billing arrangements has not been followed correctly.
Failure to operate the arrangement correctly can result in incorrect VAT treatment and a liability to repay any VAT that has been incorrectly recovered.
There is also the risk of VAT fraud where a de-registered supplier may fraudulently charge VAT, fail to pay VAT owed to HMRC or both.
Disguised remuneration schemes are tax avoidance arrangements that seek to avoid Income Tax and National Insurance contributions. This is done by paying workers who use the schemes their income in the form of loans or other payments, which are claimed to be non-taxable. This is done to increase a worker’s take-home pay and attract workers to the business.
Businesses engaging workers through labour supply chains (LSCs) need to be aware of the potential dangers of using and associating with umbrella companies that operate these types of tax avoidance schemes.
Workers can be at risk of receiving payment below the National Minimum Wage amount.
Fraud can arise anywhere within supply chains, including your own business.
HMRC acts against businesses involved directly with fraud, and those associated with the non-compliance, which often disrupts the fraud in the short term.
Without remedial and preventative action across the supply chain, HMRC often sees other businesses replacing the previous one (known as ‘phoenixsm’), and fraud resumes.
Fraud relating to smaller value contracts could be part of a much bigger organised fraud involving millions of pounds.
Organised labour fraud (OLF)
Organised criminal groups can operate in labour supply chains. Longer and more complex supply chains, where it can be challenging to monitor the full chain, can present opportunities to divert the flow of money and try to disguise fraudulent activity.
Non-compliant businesses in these models usually operate through a contrived ‘structure’ between a supplier and the workforce. The models vary and evolve quickly but the principles of the most widespread organised models are summarised in the next 3 sections.
Outsourced labour payroll fraud (OLPF)
These models are based on the movement of workers, and payroll responsibilities, from legitimate businesses to supply chains containing entities that perpetrate fraud by either not declaring or paying all of the relevant taxes to HMRC.
The commercial practice of outsourcing payroll activities is exploited by criminals, who acquire or set up companies that act as agencies or payroll providers. They often appear legitimate and charge rates that do not necessarily raise alarms.
The ‘payroll company’ will insist that they are nominated as the ‘employer of record’, either by transfer of the workforce to them or by contractual arrangement. They do this so they can charge VAT on the full value of the supply, maximising the amount of money they will attempt to divert through non-compliance.
OLPF can:
- apply to any sector
- involve VAT being charged on the supply of labour but not being paid to HMRC
- involve Income Tax and National Insurance contributions being deducted from wages but not being paid to HMRC
Mini umbrella companies (MUCs)
An ‘outsourcing’ or ‘promoter’ business, presenting as an umbrella company, splits the employment of temporary workers across multiple small, limited companies. These mini umbrella companies are set up to fraudulently exploit government incentives aimed at helping small businesses.
Each MUC employs a few workers and there can be hundreds of these companies in a single chain.
‘Stooge or nominee’ directors are usually recruited to ‘front’ these companies as an attempt to try and disguise the real control or ownership of the company. Whilst often involving overseas directors, recruitment through social media adverts is also seen, including in the UK.
MUC fraud can:
- apply to any sector
- involve the Employment Allowance being fraudulently claimed
- can involve abuse of the VAT flat rate scheme — the lower rate is paid by the MUC whilst VAT is charged and recovered at the standard rate by the MUC’s customer
- include Income Tax, National Insurance and VAT not being paid to HMRC correctly
- result in workers not receiving all that they are entitled to and losing some employment rights
- involve exploitation of ‘nominee’ directors who may themselves be vulnerable individuals
Labour fraud in construction (LFiC)
Whilst operating alongside genuine construction service supply chains, criminals create artificial chains of companies to facilitate and hide fraud.
The artificial supply chains are used to move tax liabilities related to labour, CIS deductions or both from payments made to workers, into companies. These companies then default, go missing or both.
LFiC can involve:
- VAT not being paid to HMRC
- CIS deductions not being correctly paid to HMRC
- fraudulent CIS GPS applications
It can also result in workers’ Income Tax and National Insurance contributions not being covered.
Internal fraud
Employees might participate in fraud internally, by engaging with defaulters in the supply chain. This can involve bribery, corruption and money laundering as well as tax evasion.
The employee may use their position to benefit financially from criminal activity associated with supply chains by:
- setting up a new business as a director or controlling party
- falsifying or short-circuiting the usual due diligence and assurance procedures
- recommending entities for contracts
Employees can also be targeted by organised criminal gangs and coerced into criminal activity.
Other fraud and non compliance
Tax fraud is not always carried out by organised criminal gangs and can occur anywhere in the supply chain. This might involve:
- fraudulently charging VAT on invoices when the business is not VAT registered
- correctly charging VAT on invoices but deliberately not remitting it to HMRC
- making Income Tax and National Insurance contributions deductions from workers’ pay but deliberately not remitting it to HMRC
- fraudulently claiming CIS deductions