Andrea Manzini is indirect tax specialist at Motor Fuel Group

In the world of VAT, a taxable person can be unaware of a fraud in the supply chain and still be regarded as a fraudster, if that taxable person has not properly vetted its suppliers or has ignored signs of potential connections to fraud.

There is now such a critical mass of cases where British courts ruled in favour of HMRC in these situations that practitioners and their clients must take this risk very seriously. In 2023 alone there were three high-profile successful assessments on unwitting parties for supply-chain frauds and no defeats for HMRC.

Each time, the tribunals’ decisions were driven by the ‘should-have-known’ principle. This can be summarised as follows: you may have acted in good faith, but if the tax authority can prove it was sufficiently easy to spot you were trading with fraudsters but you didn’t spot it, you must be treated as a participant in the fraud and bear any VAT loss suffered by HMRC (and often pay a hefty fine, too).

Verifications must be done regularly as fraudsters typically de-register after completing VAT registration

This may sound worrying for UK VAT-registered persons, but there is no need to panic. A robust set of onboarding procedures for new suppliers and recurring checks for existing business partners are usually enough to discharge the burden of proof in respect of whether a party should have known that it was doing business with fraudsters.

Verify regularly

You can verify the validity of the VAT numbers of all counterparts on the free HMRC and EU Commission online VAT checkers. However, it is not enough to ensure that VAT numbers are valid when new suppliers are onboarded. These verifications must be done regularly and routinely, as fraudsters typically de-register shortly after completing the VAT registration process; they initially appear as genuine and reliable traders, only to later disappear with the VAT collected but unremitted to the authority.

You should ensure that a transaction is in theory commercially viable for the suppliers. Often, fraudsters offer unsolicited, ‘too-good-to-be-true’ deals with the sole intention to charge and steal the VAT.

Multiple recirculation of goods or services through an overseas accomplice is known as carousel fraud

Be wary of suppliers with little or no trading history. Numerous checks can be done by consulting the Companies House website, where there is publicly available information on current and past directors, the year of incorporation, any change of ownership and all financial results.

For big or medium-sized entities in particular, ensure you can demonstrate that you have relevant ‘spot-the-fraudster’ policies in place and they are being implemented.

Also, make sure that the legal entity issuing the invoices is the same as the contractual party.

Susceptible industries

Although VAT frauds may occur in all industries and involve services as well as goods, some sectors are more susceptible to fraud than others – for example, those with high-frequency trades and concerning either intangible or difficult-to-trace products.

A typical VAT fraud scheme involves a fraudulent company buying VAT-free products/services from overseas, selling them domestically and correctly charging 20% VAT to an unwitting company, which pays and later reclaims the VAT from HMRC as input tax. The VAT is lost as a result of the fraudster not remitting any money to HMRC and disappearing.

The scheme can also involve multiple recirculation of the same goods or services through an accomplice based overseas, which buys from the unaware party and resells VAT-free to the UK fraudulent company, which in turn perpetrates the same VAT fraud over and over again. This is known as carousel fraud.

The government has introduced the reverse-charge mechanism for certain domestic transactions

In its VAT Manual, HMRC explains that if a taxable person has incurred input tax that is properly allowable, they are entitled (subject to certain rules) to set it against their output tax liability; and, if the input tax credit due to them exceeds the output tax liability, they can claim a repayment. However, a taxpayer who claims input tax on transactions that they ‘knew or should have known’ were ‘connected with fraudulent evasion of VAT’ will be denied their right to claim that input tax.

Government steps

Over the past 15 years, the government has legislated to prevent such frauds by introducing the application of the reverse-charge mechanism for certain domestic transactions – effectively shifting the burden of accounting for and remitting VAT from the supplier to the customer – in several at-risk industries. These include computer chips (2007), mobile phones (2007), wholesale gas and power (2014) and renewable energy certificates (2019).

A curiosity here is that players in the renewable energy sector were given only one day’s notice before the reverse charge took effect on certificates; it was announced on 13 June 2019 and implemented on 14 June 2019.

Legislation targets businesses unable to demonstrate that they have reasonable procedures in place

In 2017 HMRC was given another important anti-fraud weapon with the introduction of the Corporate Criminal Offence legislation. This targets businesses unable to demonstrate that they have reasonable procedures in place to prevent the facilitation of tax evasions by making them guilty of a criminal offence.

Until 2019, when the UK was still a member of the European Union, the European Commission published detailed statistics on the VAT gap – the percentage of uncollected VAT revenue out of the total that could in theory be collected – for the UK, too. In that year, it was reported that the UK gap was close to 9% or around £13bn, which was largely due to VAT frauds.

Businesses may find the implementation of rigorous onboarding processes and regular checks daunting. But with courts consistently backing HMRC in fraud cases, the implementation of multiple reverse-charge mechanisms and the introduction of the Corporate Criminal Offence legislation, it’s never been more important for businesses to step up their protective measures.