HMRC issued its labour supply chain risk guidance in 2021 and, anecdotally, we've recently started to see increasing levels of HMRC activity and interest in this area. HMRC are increasingly undertaking reviews into the supply chains of large businesses with ‘tax risks’ featuring heavily in those reviews.
We've been made aware of a number of circumstances where HMRC customer compliance managers (CCMs) have contacted large businesses to enquire into their labour supply chain due diligence procedures. This appears to be a brand new cross-tax approach by HMRC (covering employment taxes, indirect taxes and broader governance matters).
Labour supply chain risks and tax
Labour supply chain risks cover such areas as organised fraud (including payroll fraud, national minimum wage breaches and use of offshore entities), compliance with the Corporate Criminal Office legislation, VAT fraud and landfill tax. This initiative follows on from the introduction of the Criminal Finances Act 2017, which can potentially impose a Corporate Criminal Offence (CCO) consisting of an unlimited fine and the risk of corporate criminal prosecution for the failure to prevent the facilitation of tax evasion. The CCO legislation overarches all areas of tax and therefore aligns with HMRC's wider focus on labour supply chain risk. In our experience this is an increasing area of contention arising during procurement processes and commercial transactions, in some cases creating delays in the transaction and impacting on transaction value.
Failing to identify and manage any of the risks above would have a major impact on any business, and in the words of HMRC “could even stop your business from operating entirely”. It's therefore critical that large businesses review their labour supply chains – not just from an operational and legal standpoint but also to ensure that the supply chain is tax-compliant and that there are no unknown tax exposures.
How do tax risks impact your supply chain?
To bring HMRC’s guidance to life, here are two examples from our recent work supporting clients across these tax and supply chain governance risk areas. They show where tax risks may occur within a supply chain and how they would impact the business.
Example 1: Employment taxes
A large business used an employment agency to source IT workers. They didn't find out what trading vehicle the workers were using and assumed that as agency workers, all the supplied labour would be remunerated via Pay As You Earn (PAYE). In fact, the workers were trading via their own personal service companies and the large business, as end engagers, failed to produce the required Status Determination Statements under IR35 reforms introduced in April 2021.
This failure resulted in the large business being deemed to be the fee payer and they were held accountable for the resulting PAYE tax and Class 1 National Insurance Contributions (NIC) loss to HMRC.
Example 2: VAT
A business took on a new supplier, which charged VAT on its invoices. The business had a process in place that checked the VAT number provided by a new supplier to ensure it was genuine. As such, the business was happy to pay the VAT on the supplier's invoice. Several years later, the business was still paying the VAT on the supplier's invoices. However, it transpired that the supplier deregistered for VAT at some point but still charged VAT on its invoices. The business hadn't reviewed the VAT number since the initial setup.
Fraud had therefore taken place within the supply chain and the business didn't have sufficient controls in place to identify this. Suitable controls could include having a process to check the validity of all of its suppliers’ VAT numbers, once a year.
There's a risk that HMRC could assess the business for the VAT that it has recovered on the invoices (plus penalties and interest) as the VAT shouldn't have been charged. Given this is one-sixth of all purchases made from the supplier, this could be a large number. HMRC could also apply a penalty of up to 30% of the VAT overclaimed.
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What you can do to prepare
HMRC’s renewed initiative emphasises the importance for businesses to act now and be prepared. One of the best ways to do this is to undertake due diligence and a tax risk assessment of your supply chain processes. Through our recent client work in this area, we have been able to support our clients with risk assessments by preventing penalties from being incurred, avoiding reputational damage, and providing assurances that your suppliers undertake good business practice.
Undertaking a risk assessment supports your tax function by ensuring that your tax and ESG strategies are aligned, and that those strategies cascade appropriately through existing or future supply chain processes. For example, compliance with environmentally-focused taxes is critical to the ‘Environmental’ element, and compliance with labour policies, taxes and levies, and the CCO rules, is critical to ‘Social’ and ‘Governance' strategies.
The assessment can also support businesses by identifying tax risks that could be seen as a ‘price chip’ – negatively impacting the value of the business – as part of future transactional tax due diligence exercises. The International Labour Organisation and the Organisation for Economic Cooperation and Development (OECD) have also recommended that multinationals undertake due diligence on their supply chains, to help to eradicate forced or child labour and environmental damage.
An ounce of prevention is worth a pound of cure. More robust controls and processes can reduce supply chain tax risks and prevent fraud from occurring. With HMRC's spotlight growing in this area, acting now will help you get ahead of the curve, ensure compliance with regulations, and help protect against financial penalties and reputational damage.
For more insight and guidance, and support in undertaking labour supply chain tax risk assessments, get in touch with Paul Atherton.