HMRC targets construction industry in VAT crackdown
Written by admin on August 12, 2025
Geraint Lewis is a VAT director with Moore Kingston Smith
A flurry of recent cases has shown that the construction industry is in HMRC’s crosshairs. The tax body appears to be pursuing compliant businesses for sums owed by others.
This initiative is part of a battle between HMRC and fraudsters using staffing agencies to defraud the tax system of very significant sums. HMRC’s list of deliberate defaulters for the first half of 2025 includes at least six staff companies that, in total, have defaulted on £51m of tax.
“Frustratingly, HMRC will not provide a list of due-diligence steps for businesses to follow”
How these fraudsters operate differs, but they need an innocent victim who requires a reliable source of temporary workers and to outsource payroll and pensions. The fraudsters set up what appear to be legitimate staffing agencies that seemingly do a good job for a very competitive fee. The kicker is that someone in the supply chain neglects to pay the VAT.
The beauty of this structure for the fraudsters is that temporary staff companies can be set up quickly with the minimum of physical infrastructure, and by charging VAT on wages, National Insurance and pensions, they can process large amounts of VAT very quickly.
The problem for HMRC is that these staff agencies have few assets, making it difficult for HMRC to collect the outstanding tax. This means HMRC is directing its fire at the companies using the temporary staff – which typically have no knowledge of these events and made no financial gain from the fraud. However, for HMRC, the attraction is that these are real businesses with assets, offering the opportunity to collect the lost revenue.
‘Should have known’
While these companies are not party to any fraud, and have paid and recovered VAT in good faith, a little-known legal principal gives HMRC the basis to deny VAT deduction to businesses if HMRC can demonstrate that the business knew, or should have known, that the VAT being recovered was charged on transactions linked to a tax fraud committed by another party.
Being an innocent party, or even the victim of fraud, is not a defence – HMRC simply needs to demonstrate that a taxpayer ‘should have known’ that the transactions were linked with fraud.
HMRC argues that any business that, for example, failed to undertake a detailed supplier due diligence, or pick up on certain red flags, such as frequent name changes, suppliers with little if any electronic footprint, or very low pricing, has failed to meet the ‘should have known’ test and HMRC is entitled to refuse credit for any VAT the end customer has recovered on invoices from the fraudsters – even though those amounts were paid in good faith.
Review your processes
The litigation in these cases is complex and the outcome almost always rests on the business being able to evidence that its actions in dealing with the fraudsters were entirely above board, and that its supplier-review process was not only robust but also reviewed regularly. Frustratingly, HMRC will not provide a list of due-diligence steps that businesses should follow to give them protection against footing the bill for someone else’s fraud. The appropriate measures will depend on the nature and size of the business.
Businesses should take advice and develop their own procedures, and then ensure that any policies implemented are followed and records kept showing that due-diligence actions were taken.
The tax tribunal continues to hear many cases in this area (referred to as the Kittel Principle), which often see a victory for HMRC. Given the pressure on public finances, we can expect this trend to continue. The need for businesses to review their internal processes in this area, and never turn a blind eye, has never been greater.
