Fraud schemes with subcontractors in construction

Pan european tax administrations have identified problems with subcontractors in the construction industry. In many cases problems are similar but there are also some remarkable differences, often depending whether a reverse charge or withholding tax system is used or not. Some tax administrations have answered that there is no difference between cases detected during audits within the construction industry, involving subcontractors and typical fraud cases in other industries. The problems that have been identified are described below.

Examples given by different tax administrations have in most cases been discovered during an audit. In the first part a description of typical fraud cases is given; followed by comment on the abuse against the reverse charge system and the withholding tax system.

Typical fraud with subcontractors in the construction industry

The main typical fraud with the subcontractors is very simple: short lived subcontractors who do not declare their taxes. Another typical fraud perpetrated by subcontractors is the overcharging of the building work. The subcontractor gives the surplus, in cash, to the manager of the main company, this cash being used either to pay illegal workers or the manager keeps it.

A major building project requires the employment of a large number of construction workers. The records of most companies are frequently inadequate for this situation many employees are not shown nor are the amounts of their salaries or expenses. The companies have not correctly reported the number of employees and are paying them off-record in cash. Also, the company declares a higher input tax figure on its VAT returns, and is requiring a VAT refund. The general finding is that companies are issuing fictitious documents with invoiced services that have never been undertaken. Many submitted documents appeared to be fraudulent.

An example given by the Italian tax administration showed that during a check at a construction company, documents were found relating to the subcontracting companies but no employee of this company was present on the site. Subsequent investigations revealed that the owners of the subcontracting firms were in fact simple workers, employees of the contractor, who did not know they were meant to be owners of this company. The contractors themselves created false invoices and fictitious costs through this false company.

There are cases in practice where the subcontractor invoices to the contractor for the work carried out, and then the contractor omits to invoice the investor for a longer period of time.

The most frequent fraud is:

• Making out an invoice for non-performed services;
• Creation of an invoice by an entity not authorized to issue invoices or by a non-existent entity;
• Making a sale without issuing an invoice (the sale would not show on the tax return) or making out an invoice for services with amounts that do not correspond to the actual costs;
• Showing a large income without employing any workers or having any equipment;
• Making input tax deductions for the renovation and modernization of a dwelling or residential building on the basis of “handled” VAT invoices in collusion with builder’s merchants.

The main problems:

• In a subcontracting chain one company is refunding VAT but the other has not paid this VAT;
• Use of false/fictitious invoices;
• Payment of black wages.

These schemes are very difficult to detect without co-operation from the police. In almost every case their co-operation is needed.

The audit actions typically consist in: meeting with the police, raiding the construction site or/and the premises of the company or/and to homes of the people involved, audit of the bookkeeping, police interrogations, and bank enquiries.

When a visit to the construction worksite is made, the first important step is to identify workers.

Information is requested directly from the individual worker and in some cases, the employee may be asked to fill in a questionnaire. Some tax administrations (the Netherlands) have prepared questionnaires in a number of languages to help workers of other nationalities. Questionnaires include a number of questions such as: citizenship, residence permit, work permit, date of hiring, salary, date of payment of wages, hours of work.

Typically, this type of control allows for the discovery of illegal workers and also of non-compliant subcontractors. Another important purpose of site visits is to monitor the enforcement of legislation on social security as well as the payment of social contributions.

Checks for professional qualifications are not done by the tax administration. This is in some countries a task of the inspectorate general of labour; otherwise this information must be provided by the principal contractor.

The results of visits to construction sites are used as a starting point for subsequent control of subcontractors. If there is any evidence of evasion of social security contributions, this information is sent to the relevant organisations responsible for more intensive controls.

An advantage provided by these controls is the accumulation of data and information that gives a better understanding of the construction industry. In this way the tax administration can better understand the mechanisms of fraud.

Some tax administrations already have groups of experts in the field of construction; others are considering setting up specific groups to that end. Some administrations’ experiences revealed that the involvement of experts from different areas of the construction sector, even if it took more time and appeared to cost more, ultimately brought better results.

If irregularities are found during the inspections, the companies that are involved are penalized in various ways, usually with fines, with the suspension of their tax number, or even the temporary suspension of the yard.

These penalties have a major deterrent effect upon taxpayers.