In November 2025, the previous Chancellor set out plans, among other things, to tackle fraud within the Construction Industry Scheme (“CIS”) and announced a technical consultation “aimed at simplifying and improving the administration of the scheme”.
It is not a surprise that there is significant interest by HMRC in the construction and property sector, given the increased number of enquiries that being made into businesses within the industry.
This comes alongside an influx of cases in the Courts and Tribunals relating to fraud along the supply chain in construction and building services.
Although the types of tax enquiries that we are seeing in the construction industry are varied, there are steps that businesses within the sector can take to best protect themselves from a length tax investigation or dispute.
VAT enquiries
What can seemingly start off as a few questions into a particular VAT return or a handful of invoices can soon escalate to a full enquiry.
In particular, we have seen that HMRC is asking for a significant amount of documentary evidence to support claims for VAT which, in a historically paper-heavy industry, can be difficult to collate.
HMRC is also increasingly looking to apply the Kittel principle, which sets out that the right to deduct VAT could be denied where the taxable person knew or should have known that the transaction was connected with fraudulent evasion of VAT.
For example, if Company A engaged with Company B (an agency used to source labourers) and Company B was committing VAT fraud, HMRC would consider whether Company A knew or should have known about the fraud. In doing so, HMRC would consider whether the arrangement with Company B was ‘too good to be true’, what due diligence checks were undertaken on Company B, and whether there were any obvious red flags
There is no single approved checklist to make sure sufficient due diligence has been undertaken. Checking a supplier’s VAT registration number is one step, but we have increasingly seen HMRC take the position that traders should have gone further, for example by visiting suppliers’ premises, holding meetings with the individual directors, or even having news alerts on the directors and the supplier itself. A robust due diligence process is invaluable and keeping up-to-date and accurate records is necessary.
For example, in the recent Kittel case of Opus Labour Services Ltd v HMRC, the First-tier Tax Tribunal held against the taxpayer and confirmed that it should have known that its outsourced payroll arrangements were connected to a VAT fraud. The Tribunal commented on the taxpayer’s prior knowledge of VAT fraud and wholly inadequate approach to due diligence.
More recently, in Harlequin Brickwork Ltd & Ors v HMRC, it was alleged that three construction companies knew or should have known that a labour supplier to whom they outsourced their workforce was fraudulently failing to account to HMRC for VAT in its supplies to the three companies. Although the taxpayers’ appeals were accepted, the Tribunal considered the “knew or should have known” test on a hypothetical basis and commented on the “absence of any verified explanation”, where it could not be reasonable for Harlequin to proceed on the basis that VAT was being properly accounted for. See here for more information on how to protect your business from HMRC input VAT claim refusals.
CIS returns
Whilst CIS remains the central framework for how contractors operate payroll and deductions for subcontractors, HMRC is increasingly challenging CIS returns and questioning whether the payments were correct. HMRC is also likely to use CIS records and payroll inconsistencies as a source of information for broader fraud enquiries.
HMRC have now extended the Kittel principle to CIS payments, confirmed in the Finance Act 2004 (sections 57 – 77 and Schedule 11 and 12) and HMRC’s internal manual (CISR85000). To tackle supply chain fraud in the construction industry], from 6 April 2026, where a business makes a payment that it knew or should have known was connected to fraud, HMRC will be able to:
- immediately remove Gross Payment Status (“GPS”) — those who have GPS status removed due to fraud or serious non-compliance will be prevented from reapplying for GPS for a period of five years;
- assess the business for the related tax loss; and
- charge a penalty of 30%, which can apply to the business or its officers (subject to mitigation).
Other grounds for immediate GPS cancellation are where a business provides false information at registration for GPS, has fraudulently made an incorrect return or provided incorrect information, or has knowingly failed to comply with a CIS obligation.
It is therefore important for businesses to ensure they carry out robust due diligence checks to avoid engaging with any suppliers involved in fraud.
Record keeping
Whilst it can be difficult to keep track of paperwork in a busy business, HMRC has high expectations for taxpayers to maintain records.
Whilst HMRC officers are experts in their fields, they cannot be expected to understand every sector in which they have open enquiries, and so it is important to ‘translate’ records in such a way that HMRC can understand them. This could mean working through a transaction from start to finish and providing HMRC with the relevant documents for each stage, or even marking up a document to explain what each entry means.
Summary
With the tax gap currently standing at £59.2 billion, HMRC is looking across all sectors to try and raise funds. It is almost inevitable that, going forward, HMRC will continue to increase investigations into the construction industry.
Whilst it is stressful when a brown envelope lands on your doorstep, taking swift action can help avoid years of lengthy correspondence with HMRC. Completing a regular review of the business’s procedures and policies, together with robust record keeping and due diligence checks, can help move enquiries to a swift conclusion.
If you have any questions about any of the information in this article, please do not hesitate to reach out to our Tax Disputes and Investigations team.
