Payroll Frauds by Brett Eeles
As a liquidation finance company, one particular type of claim which has come across our desks more frequently over the past 18 months relates to companies who appear to have been operating so called ‘outsourced labour payroll frauds’.
Often significant monies can be siphoned out of companies operating these frauds and when HMRC discover there are issues and petition for tax liabilities (or threaten to do so), the directors often place the Company into CVL or allow it to collapse into compulsory liquidation and abscond, having deleted the books and records.
Given its seemingly increasing prevalence, Insolvency Practitioners should be aware of this type of fraud so they are able to identify it and pursue the perpetrators for the benefit of the insolvent company and its creditors.
What is outsourced labour payroll fraud?
It is a form of tax fraud, usually involving VAT and PAYE. 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. 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 will seek to exploit this in the following way:
- They will employ workers and supply them to their client. Sometimes the umbrella company will suggest the client transfer its employees to them and that they will then second them back. They 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 PAYE returns.
- Submit an invoice to the client at month end based on the entire payroll plus VAT, sometimes including a fee (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 fraudulent company 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 and keep the difference.
The end client will often be unaware of the fraud or that there has been any under-declaration of tax.
How to spot outsourced labour payroll fraud
As with all frauds, the key red flag is where the fraudulent company is purporting to offer something to its clients that is too good to be true. Certain signs to watch out for include the following:
- Payroll companies requesting a client to transfer its staff to them.
- A company offering to run a client’s payroll for free or for a minimal fee that seems too good to be true.
- A company offering kickbacks and incentives. 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.
- A legitimate payroll company with the same or a similar name to the company.
How to pursue it
Again, as with all frauds, it is necessary to follow the money and identify any unexplained transfers or withdrawals from the company to specific entities or individuals. Fraudsters will often hide themselves behind others. It is important to identify who was really in control of the entity including any shadow or de facto directors.
We have found it particularly useful to review historic versions of the companies’ 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 company was charging VAT to its clients which can then be compared with the company’s VAT returns, if indeed VAT returns were being filed at all.
Finally, PAYE returns can be compared to the sums shown in invoices or the sums paid to employees in the Company’s bank statements.
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.
Brett Eeles
Associate Director
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.