Another change on 6 April this year in the finance act that has largely flown under the radar are important additional powers for HMRC when supply chain fraud is expected in the Construction Industry Scheme (CIS). These changes allow HMRC to adopt the Kittel principle that is currently used in VAT law: The principle allows HMRC to penalize businesses that knew, or should have known their transactions were connected to fraudulent tax evasion.
Key Aspects of the Kittel Principle for CIS:
- The "Knew or Should Have Known" Test: A business can be held liable if it knew, or ought to have known, that its payments to subcontractors were connected to fraudulent evasion of tax.
- Expansion into CIS: While historically used for VAT, this approach is being widened to CIS, allowing HMRC to act against fraud in labour supply chains where fraudulent subcontractors fail to account for tax.
So in simple terms, if you pay a Gross payment holding sub-contractor, and they don’t pay their CIS, you could potentially be held liable!
The Core Principle: "Knew or Should Have Known"
- This is the most critical aspect, often described as "Nelsonian" or "turning a blind-eye" knowledge. It applies if a reasonable person, in the same circumstances, would have suspected fraud, or if the only reasonable explanation for the transaction was fraud.
- Expansion of Liability: Unlike traditional CIS, where contractors are only responsible for deducting tax, this new measure makes them responsible for tax evasion carried out by others in their supply chain.
- Consequences of Fraudulent Connection: If a business fails this test, HMRC may take the following actions:
- Cancel Gross Payment Status (GPS): Immediately remove the business's ability to receive payments without deduction.
- 5-Year Ban: Impose a five-year ban on reapplying for GPS.
- Tax Loss Recovery: Hold the business responsible for the tax losses.
- Penalties of up to 30%: Charge penalties to the business or its directors.
So how do you protect yourself from this risk? Key 'Kittel' Due Diligence Steps for CIS
HMRC suggests verifying that your supplier is legitimate by taking the following steps:
- Verify Identity: Use Companies House to check the company’s history and identify the directors.
- Check VAT Registration: Verify VAT numbers with HMRC regularly.
- Verify Licenses: Check for necessary licenses, such as a Gangmasters and Labour Abuse Authority (GLAA) license, if applicable.
- Financial Health checks: Perform credit checks or other background checks.
- Understand the Supply Chain: Determine if there are too many layers of subcontracting (which increases fraud risk).
- Verify Workforce: Know the relationship between the worker and the provider, and check that workers have the right to work in the UK.
- Visits and Meetings: For high-risk, large-volume, or new suppliers, conduct site visits or hold face-to-face meetings with directors.
HMRC expects you to act if you notice any of the following "red flags":
- Prices too good to be true: Subcontractor rates that are significantly below market rates.
- Incomplete/Missing Info: Supplier cannot provide proper invoices, contracts, or identification.
- Unusual Payment Terms: Requests for payment to third-party bank accounts or offshore accounts.
- Sudden Changes: A sudden change in a subcontractor's bank details or ownership.
Yet more risk and admin for genuine businesses to worry about, with no reward!
At EEBS, we specialise in CIS payroll and compliance — so if these changes have raised questions about your supply chain processes, we're here to help. Whether you need a due diligence review or just want to understand what this means for your business, get in touch with our team today.
