Select Committee on European Union Twentieth Report

CHAPTER 3: FURTHER ADMINISTRATIVE ACTIONS

41.  As well as the measures taken to date considered in chapter two, the evidence we received suggested further administrative solutions. In this chapter we address these.

Scrutiny of new VAT registrations

42.  The Paymaster General told us that enhanced measures are in place to monitor applicants for a VAT registration, and that these are processed within a reasonable time period despite these checks (QQ 232-233). Representatives from trade suggested that this work could be extended, with newly registered firms closely supervised—including on-site visits and examination of business plans—until they have demonstrated that they are trading legitimately (Q 288). Security for VAT due could be requested from newly registered businesses in sectors where risk of fraud was considered to be high (Q 306).

Real-time logging of trades and verification of counterparties

43.  Some witnesses suggested that HMRC should concentrate its resources on monitoring transactions in real-time (or near real-time), hopefully uncovering non-economic transactions as they occur (p 121, Q 192, 303-304). HMRC have calculated the cost of such monitoring at £1.3 billion (p 64)—an amount which they might recoup in less than a year at current levels of fraud. It is likely that there would be significant transition costs for business, although a reporting threshold could be introduced to ensure small businesses and charities are not over-burdened.

44.  HMRC indicated that it is already using technology to perform a more sophisticated analysis of VAT returns to identify rising levels of fraud in different sectors (Q 334). But this analysis is made only on the basis of returns submitted. A considerable lag can occur between the initial charge of VAT by a trader, who then disappears, and the recognition of fraud when traders later in the transaction chain request reimbursement of VAT paid.

45.  Any new online system for reporting trade must be "hacker proof", but it is clear from the credit card industry and from intra-bank payment systems that reliable technology exists to handle and transmit high volumes of transaction data in a secure environment. The collection of data (including the VAT registration numbers of the supplier and purchaser, the sales price, and the nature of the goods traded) at the time of transaction, as proposed by some witnesses (Q 304), combined with HMRC's analytical capability, could act as first line of defence against an expansion of MTIC and other frauds. Alternatively, it could act as means by which legitimate business could gain "clearance to trade" and immunity from verification. We suggest that HMRC should undertake further work to examine the viability of real-time data capture of transactions by VAT-registered companies.

46.  The Construction Industry Scheme[32], which sets out the rules for how payments to subcontractors must be handled by contractors in the construction industry, allows contractors to check the taxable status of subcontractors online. There appears to be no reason why this scheme cannot be extended to industry sectors where Missing Trader Fraud is common to enable legitimate companies to verify the status of their trading partners.

Collection of VAT in real-time

47.  An extension of a real-time VAT monitoring scheme might see HMRC collect the VAT due as the transactions are made. Traders would be required to open a separate bank account, monitored by HMRC, into which they would transfer an amount equal to the VAT charged to their customers. This might happen automatically as part of the logging process, or the database could generate invoices for firms to pay within a short period. HMRC would pass a trader's VAT claim for payment once HMRC were satisfied that the claimant's supplier had deposited the VAT income—a strong incentive for purchasers to ensure they were trading with a reputable organisation.

48.  Aside from the administrative cost, such a scheme might also create a shortage of working capital, as businesses would no longer be able to hold VAT income until their quarterly return to HMRC.[33] This would particularly harm small businesses.

Containment or Prevention?

49.  The proposals we have considered in this chapter could prevent MTIC fraud to some degree, but none will stop this crime. Furthermore, these proposals, like HMRC's existing strategy, impose ongoing costs on business—either directly from increased administrative costs, or indirectly from cash-flow constraints caused by delayed verification of repayments. The Institute of Chartered Accountants in England and Wales likened extended verification to preventing a series of thefts at a windowless jewellery shop by controlling those who could walk past it, rather than putting glass in place (Q 173).

50.  HMRC agree. They told us that "from an operational perspective … it is always the best solution to change the rules so that things cannot happen in the first place. Any enforcement activity is always going to be following on after the event or in response to a failure … of those rules, so getting the rules right … is obviously what we want to do. That is often easier said than done." (Q 348)

51.  HMRC's current strategy has succeeded in containing MTIC fraud, but will not eliminate it; the Government sought the reverse charge derogation because HMRC's current strategy is unsustainable. The reverse charge will stop MTIC fraud where it has been most prevalent, but we expect the fraud to migrate and mutate. Consequently we anticipate that when the UK's derogation is reviewed in two years time there will be requests for the reverse charge scheme to be expanded, either to other Member States or other products, or both.

52.  The current mechanism for intra-Community VAT transactions is not sustainable. While the amount of money being lost in the United Kingdom may have fallen in 2006/07, mutation into other industry sectors will bring a subsequent rise in fraud levels. We believe that prevention is better than cure. A wide-ranging change to the VAT system is required and the Government should start discussions with the European Commission and other Member States on the form this should take. The next chapter examines some of the options for change.

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32   An HMRC scheme setting out the rules for how payments to sub-contractors for construction work must be handled by contractors in the construction industry and certain other businesses. Back

33   This problem might be overcome if a system of "trusted third parties" is introduced to act as a guarantor for firms' VAT payments; however it is likely that these would place some cost on business. Similar systems are already used to collect Sales Taxes in some American states. Carousel Fraud in the EU: A Digital VAT Solution Richard T Ainsworth, Tax Notes International 1 May 2006. Back