-
News
-
Blog
-
Archive
VAT fraud in the property and construction sector especially through complex supply chains and labour-only arrangements has been a persistent target for HMRC. This article explains what's driving the scrutiny, how the Domestic Reverse Charge (DRC) works, where the labour supply loophole arises, the nature of the crackdown and risks, and the practical steps contractors and subcontractors should take now.
Working in construction? See our specialist support for contractors and subcontractors under the Construction Industry Scheme (CIS): CIS Services for Subcontractors & Contractors.
What's Going On?
- Why construction is in focus: long supply chains, frequent subcontracting, and rapid company turnover can hide missing-trader fraud and false VAT claims.
- HMRC's response: targeted audits, the Domestic Reverse Charge, data-matching using CIS, real-time analytics from Making Tax Digital (MTD), and joint working with other agencies.
- Who's affected: main contractors, developers, specialist trades, and labour-only subcontractors particularly those dealing in “specified construction services” commonly covered by the DRC.
Domestic Reverse Charge (DRC): The Core Anti-Fraud Measure
What it is: For many B2B supplies of construction services in the UK, the supplier does not charge VAT. Instead, the customer accounts for VAT via the reverse charge. This denies fraudsters access to VAT collected from customers that might otherwise go missing.
When it applies (high level):
- Both supplier and customer are VAT-registered, and the supply is within the scope of the Construction Industry Scheme.
- The services are not to an end user (e.g., a developer using the service themselves) or an intermediary supplier connected to an end user.
- The supply is one of the specified construction services (e.g., groundworks, plumbing, electrical, roofing, painting, civil engineering) or materials supplied with those services.
When it does not apply:
- Sales to end users (the business that will use the building or service) or to intermediary suppliers linked to an end user if correctly notified.
- Zero-rated supplies (e.g., certain new builds), purely design/architectural or professional services, and some hire of goods without labour.
- Supplies to consumers (non-VAT registered customers).
What you must show on the invoice:
- A clear note that reverse charge applies (e.g., “Customer to account for VAT under the Domestic Reverse Charge for building and construction services”), plus the VAT rate that the customer must apply.
- No VAT charged on the net amount where DRC applies.
The Labour Supply Loophole: Where Fraud Creeps In
The risk: Chains of labour-only suppliers can be used to buffer or launder labour costs. A company mid-chain charges VAT it never pays over, then disappears “missing trader”. Others attempt false input VAT on fabricated invoices or under-declare payroll taxes.
How it looks in practice:
- Short-lived entities with minimal substance providing labour at suspiciously low margins.
- Invoice mills where descriptions are vague “labour services for works” and CIS, VAT, or payroll records don't reconcile.
- Use of umbrella or off-payroll intermediaries with weak KYC and no evidential trail of workers.
Why DRC helps but doesn't solve everything: DRC cuts off the outlet for output VAT fraud, but fake input claims and payroll/CIS leakage can still occur if controls are weak.
HMRC Crackdown and the Risks
What HMRC is doing:
- Thematic inspections focusing on DRC errors, end-user declarations, and CIS vs VAT inconsistencies.
- Data-matching: comparing CIS returns (gross payments, deductions) with VAT and payroll data to flag anomalies.
- Supply-chain due diligence tests asking contractors to evidence checks on suppliers.
- Assessments and penalties: for incorrect VAT treatment, careless errors, and deliberate inaccuracies.
- Joint enforcement: with insolvency and fraud teams to tackle phoenixing and missing traders.
Your exposure if you get it wrong:
- VAT assessments (plus interest) for under-declared output VAT or over-claimed input VAT.
- Penalties ranging from carelessness to deliberate behaviour.
- Denied input tax where supplier due diligence is inadequate.
- Cash-flow shocks if HMRC withholds repayments or imposes security notices.
Other Aspects You Need to Know (to “de-risk” today)
1) End-User and Intermediary Notifications
If you're an end user (e.g., developer using the service) or an intermediary supplier connected to an end user, you should notify your suppliers in writing. Without this, suppliers may incorrectly apply DRC and you could face VAT and contract disputes downstream.
2) Materials vs Services
Where a single supply includes labour and materials integral to that labour, the DRC normally applies to the whole supply; splitting lines to avoid DRC is risky unless there is a genuine separate supply.
3) CIS Alignment
Check that your CIS treatment (gross/standard deductions, subcontractor status) aligns with your VAT treatment. Mismatches are a common HMRC enquiry trigger.
4) Pricing & Cash Flow
- Suppliers operating mostly under DRC won't collect output VAT, which can reduce VAT liabilities but also remove a source of working capital.
- Main contractors buying under DRC must reverse charge VAT (no cash out on VAT), but still need to manage net payment terms and CIS flows carefully.
5) Evidence and Due Diligence
- Verify VAT numbers, legal names, and bank details; keep proof (screen grabs, lookups).
- Maintain contracts, job specs, end-user notifications, timesheets, site logs, and proof of supply.
- Monitor pricing anomalies and short-lived suppliers update your risk list each quarter.
Practical Compliance Checklist
- Scoping: Confirm if a job is within specified construction services and within CIS.
- Status: Are both parties VAT-registered? Are you supplying an end user or intermediary? Obtain/issue written notifications.
- Invoicing: If DRC applies, do not charge VAT; add a correct reverse charge statement and rate.
- Bookkeeping: Use correct VAT codes in your software; reconcile CIS and VAT each month.
- Supply-chain KYC: Collect supplier due diligence (VAT/CIS status, insurance, director checks).
- Review rhythm: Quarterly review of DRC invoices, end-user notices, and any credit notes.
- Training: Toolbox talk for site managers and admin teams on when DRC applies.
Red Flags HMRC Looks For
- Frequent amendments/credits to the same invoices.
- Suppliers with no online footprint, no fixed address, or serial director changes.
- Uncommercial rates for labour or persistent rounding.
- Large input VAT claims with minimal output VAT due to near-universal DRC supplies, but weak evidence of purchases.
- CIS returns that don't reconcile to payroll and VAT data.
Who Should Own This Internally?
- Commercial/Contracts Manager: end-user/intermediary notifications embedded into contracts.
- Accounts Payable/Receivable: invoice templates and VAT codes; supplier KYC.
- Payroll/CIS Lead: aligns CIS and VAT; timesheet and deduction accuracy.
- Finance Lead/FD: quarterly reviews; risk register; training cadence.
How We Help (in Construction)
- Health check: quick DRC/CIS review and invoice sampling.
- Supply-chain clean-up: due-diligence pack templates and onboarding flows.
- System fixes: VAT coding, software rules, and end-user notification templates.
- Enquiry support: preparing evidence, responding to HMRC, and negotiating outcomes.
Conclusion: Make DRC Routine, not a Risk
HMRC's focus on property and construction VAT is not going away. Treat the Domestic Reverse Charge as a normal part of your workflow scope the job, document end-user status, invoice correctly, and reconcile CIS with VAT every month. Tighten supplier due diligence and maintain clear evidence trails. With disciplined processes, you'll neutralise the fraud risks HMRC targets, protect cash flow, and avoid costly disputes so you can concentrate on delivering projects safely, on time, and profitably.
If you want a quick, practical assessment of your risk and fixes you can implement in days, tap our construction team via the CIS link above.