Payroll Frauds

As a solicitor at a litigation finance company, one particular type of claim which has come across my desk (and those of my colleagues) with increasing frequency in recent times relates to companies that appear to have been operating so called “outsourced labour payroll frauds”.

Often significant monies will be siphoned out of the companies operating these frauds and when HMRC discover that there are issues and petition for tax liabilities (or threaten to do so), the directors will place the Company into voluntary liquidation or allow it to collapse into compulsory liquidation and abscond, having deleted the books and records, leaving a trail of destruction in their wake.

Given its seemingly increasing prevalence,  it is important for companies and their professional advisors to be aware of these types of fraud. Whilst HMRC is undoubtedly the primary victim it is important for companies to understand that it can have serious financial consequences for both them (as employers) and their individual employees. In the case of companies, this includes, for example, having what they had assumed were legitimate input VAT claims denied, even if they were unaware of the fraudulent nature of the scheme. In the case of individual employees, their individual tax situation may not have been dealt with properly for months if not years which may expose them to claims for underpaid tax and penalties, through no fault of their own.

It is therefore important to be vigilant for the red flags which usually accompany such a fraud and avoid falling victim to them.

What is outsourced labour payroll fraud?

Outsourced labour payroll fraud is a form of tax fraud, involving the manipulation of either VAT or PAYE and in my experience, usually both at the same time. The nature of the fraud is actually quite simple albeit it can sometimes be obfuscated under layers of seemingly complex contractual arrangements.

Within the payroll services industry there are various forms of offering. Some payroll service companies will simply administer a client’s payroll and charge a fee to their client for doing so. Some other providers will go further and actually employ or at least purport to employ individual contractors or workers and supply these to their clients. These are sometimes called “umbrella companies”. We stress that many businesses supplying these services will be legitimate businesses. However, it is in this latter sector where we have seen various potential significant frauds occurring.

Whilst there are exceptions, the supply of labour is, generally speaking, a vatable supply. Fraudulent companies (which I will call “suppliers” below) will seek to exploit this in the following way:

• The fraudulent supplier will employ workers and supply them to their client. Sometimes the supplier will suggest the client transfer its own employees to the supplier and that the supplier will then second them back. The supplier may produce bogus contracts purporting to document this arrangement and suggest it is entirely legal and will “remove the hassle” of payroll for the client, in addition to any employment law related issues or responsibilities for the client.
• Administer the payroll and pay the client’s employees/workers as well as submitting the client’s PAYE returns;
• Submit an invoice to the client at month end based on the entire payroll plus VAT, sometimes including a fee for their services (but not always). Because the VAT figure is calculated by reference to the total monthly payroll cost, the figures involved become large quickly.
• The client will then pay the invoice (including VAT) at month end and reclaim the VAT it has paid. Because the end client can reclaim the VAT it has paid, it is VAT neutral from its perspective.
• The supplier will then fail to declare or under declare the VAT it has been charging (and received) and siphon off the difference to those in control of the company or entities connected to them.
• In addition and separately the fraudulent company may also manipulate the PAYE returns it files to under-declare salaries and the PAYE payable to HMRC. It will charge the client at the full amount of the salaries including PAYE and then keep the difference.

The end client will often be unaware of the fraud or that there has been any under-declaration of VAT or PAYE until the supplier collapses into an insolvency process. The supplier may have been perpetrating the fraud for years in the meantime.

How to spot outsourced labour payroll fraud

At the extreme end, the fraud is marketed on the basis that the supplier will run its client’s payroll and/or employ a client’s employees for free. The justification for this is usually opaque, however, if pressed the fraudster will usually suggest that it has some complex arrangements behind the scenes which the client will not understand, because it is not an expert in tax or employment law or similar, which allow it some form of beneficial tax treatment which will enable it to fund the scheme.

At the less extreme end, the fraudster may market the scheme on the basis that it comes with a minimal cost whilst at the time providing various rewards or kickbacks to the customer.

Particular signs to watch out for include the following:

• A supplier which has only recently been incorporated and where there is limited information about it at Companies House.
• A legitimate / well known payroll company with a similar name to the supplier.
• A supplier requesting a client to transfer its staff to them.
• A supplier offering to run a client’s payroll for free or for a minimal fee that seems too good to be true.
• A supplier offering kickbacks and incentives that seem too good to be true. For example, offering to lend the client money to pay its payroll interest free, or to pay a cash amount back to the client after payment of the invoice.

Checks which can be undertaken include asking for details of the supplier’s VAT registration and asking to see its VAT returns.

If an employer is unsure they should ask their professional advisors for their view on the scheme.

In basic terms and to quote the old idiom, “If something seems too good to be true, it usually is”.

How to pursue it

From the perspective of insolvency practitioners and litigation solicitors who might pursue the fraudsters, as with all frauds, it is necessary to follow the money (which usually requires reviewing the Company’s bank statements as a first step) and identify any unexplained transfers or withdrawals from the company to specific entities or individuals.

We have found it particularly useful to review historic versions of the suppliers’ websites to see what they were purporting to offer their clients and how (if at all) they were explaining their business model to clients or employees. Further, example invoices from clients can be important to demonstrate that the supplier was charging VAT to its clients which can then be compared with the company’s VAT returns (which will usually show minimal vatable supplies), if indeed VAT returns were being filed at all. PAYE returns can be compared to the sums shown in the supplier’s invoices or the sums paid to employees in the supplier’s bank statements. Finally, significant discrepancies in accounting information such as the supplier’s accounts revealing no employees in one year and hundreds in the next or similar.

Once the targets have been identified claims can usually be pursued on grounds of fraudulent trading, breach of duty, knowing receipt, dishonest assistance and/or conversion.

Author: Brett Eeles - Associate Director, Manolete Partners Plc | brett@manolete-partners.com | 07958 650269

Manolete Partners Plc is an investment business focused on dispute finance. It is not a law firm and does not provide legal advice. The information provided in this article is correct at the time of publication.