Memorandum by the Chartered Institute
of Taxation
INTRODUCTION
1. The Chartered Institute of Taxation (CIOT)
is pleased to submit evidence to the UK Parliament European Union
Committee in relation to carousel fraud.
2. While the nature and extent of carousel
fraud give rise to particular concerns, the CIOT considers that
it is appropriate to consider options that will be capable of
meeting both current and future attacks on the tax system. In
particular, it is important to note that legislation to counter
one threat very often simply changes the nature of the threat
and so solutions need to take into account likely new threats
arising.
3. This paper commences by examining the
nature of carousel fraud and then considers the questions set
out in the Call for Evidence. In essence, the CIOT believes that
fraud arises because it is possible for tax due to HMRC to come
into the hands of criminals, and for them to disappear before
it is paid over. The key to countering fraud is to prevent this
happening, and that requires real-time information.
4. A solution that collects the correct
amount of tax by penalising innocent traders is intrinsically
unfair, and is likely to be detrimental to business as a whole
as well as to taxpayer co-operation.
5. As with other threats to the country,
it can be expected that there will be continuing attempts by criminals
to attack the system. Accordingly, the long-term sustainability
of any system needs to be considered.
THE NATURE
OF CAROUSEL
FRAUD
6. Carousel fraud arises because EU law
allows goods to be acquired by a business in one member state
from a business in another without immediate payment of VAT. A
return to the system of border controls with VAT being paid on
importation would prevent this, but would also hinder the free
movement of goods, an essential feature of the single market.
Accordingly, it seems unlikely that a return to VAT on importation
would be an acceptable solution.
7. As VAT due on acquisition is recoverable
in the same return so that no net cash amount is due to the tax
authority, a criminal can sell goods to third parties at a price
below their normal selling price because there is no intention
to pass on the VAT that should be paid to HMRC. Since HMRC, will
only know that the VAT has been lost when the business importing
the goods free of VAT disappears without paying the VAT on acquisition,
the key problem is really one of timing.
8. Because the criminal must both sell the
goods and collect the cash for the fraud to work, prevention of
the fraudulent sale of goods or prevention of the cash being paid
to the criminal are the two ways in which the fraud can be countered.
ARE THERE
GAPS IN
THE LEGISLATION?
9. The heart of the VAT system lies in the
fact that registration for VAT carries with it two main consequences,
ie:
— the VAT registration represents a
licence to collect VAT on behalf of HMRC—in effect, a registered
business is given "credit" by HMRC; and
— the VAT registration also allows
a business to deduct VAT incurred on taxable and certain other
supplies or allows it to acquire goods free of VAT.
There are therefore both output and input tax
consequences as a result of being registered for VAT.
10. As already noted, the ability to perpetrate
VAT fraud arises because the criminal can engineer a situation
where he is licensed to collect VAT for HMRC but has no intention
of paying it over to them. However, it should also be recognised
that fraud can be perpetrated by hi-jacking a legitimate business's
VAT registration, ie similar to credit card theft where someone
clones another person's credit card.
11. It will be apparent that, because VAT
is a self-assessed tax, it is a feature of the tax that there
will always be hundreds of thousands of businesses holding VAT
that is payable to HMRC. Striking at the situation where taxpayers
are licensed collectors of the tax strikes at the very heart of
the system. In the normal course of events, the vast majority
of the tax does, in fact, get paid over because most taxpayers
are inherently honest, or at least not prepared to commit fraud.
12. Carousel fraud involves a deliberate
assault on the system— targeting a particular weakness,
but other weaknesses also exist. Further, the "reverse charge"
system has its own inherent weaknesses because a business can
still acquire goods and sell them without VAT, albeit it is more
difficult because sales have to be to individuals and other entities
that are not registered for VAT, which means that the logistics
of perpetrating fraud on the scale currently experienced are reduced.
13. It is also important to note that the
reverse charge has been used for other high-value goods, such
as gold and precious metals. The very fact that the scheme has
had to be used in other cases suggests that there may be other
goods that could be used to perpetrate fraud once the reverse
charge is applied to mobile phones and computer chips.
14. The same situation occurs with excise
duty, where large-scale fraud occurs in relation to tobacco products
so criminals are prepared to smuggle goods into the UK free of
duties and sell them on the thriving black market that exists.
15. It should also be recalled that there
was wide non-compliance with ordinary VAT regulations until 1985,
when new penalties were introduced to deter non-compliance. In
essence, therefore, it can assumed that there will be deliberate
or innocent non-compliance, whatever the nature of the taxing
legislation, unless the system is backed up with measures that
identify error in time to prevent any damage to the system.
MEASURES TO
COMBAT FRAUD
16. Until the decision of the European Court
of Justice in the case of Bond House Systems Limited (and others)
v HMRC (Cases (C-354/03, C-355/03 and C-484/03), HMRC had
sought to deprive certain traders of a right to deduct where the
VAT claimed had not been paid over to HMRC as output tax. It was
claimed that, because the seller was involved in fraud, there
was no business transaction and therefore the "VAT"
charged was not input tax.
17. The solution adopted would have curtailed
revenue loss but, in the view of the CIOT, was deeply flawed,
since it did nothing to target the criminals, and effectively
simply sought to prevent revenue loss by making some other, more
easily targeted taxpayer, underwrite the tax due from the criminal.
Such a solution is deeply offensive to right-thinking individuals,
except when the rules of tort (delict in Scotland) apply.
18. Further legislation was adopted in the
2003 Finance Act amending VAT Act 1994 Schedule 11 para 4 to combat
VAT fraud. The legislation was challenged in the case of C
& E Commrs and Attorney-General, v Federation of Technological
Industries (Case C-384/04). The European Court of Justice
effectively allowed the measures, but only where the taxpayer
"... knew, or had reasonable grounds to suspect, that some
or all of the value added tax payable in respect of that supply,
or of any previous or subsequent supply, would go unpaid".
19. The proviso creates serious difficulties
in enforcing the legislation because it creates a subjective test
whereas, in a self-assessed tax, it is important, as far as possible,
to use only objective tests so as to achieve legal certainty.
Taxpayers will argue that any HMRC view will be made with the
benefit of hindsight while it is difficult to see how HMRC, who
have wide powers to access third party information, can really
form an opinion of what the taxpayer ought to have known when
the transaction was concluded. The CIOT understands that, despite
EU case law, HMRC continue to attack taxpayers rather than the
actual criminals.
20. FA 2006 introduces measures shifting
the burden of accounting for the tax to the recipient of a supply
rather than its being paid by the supplier (the "reverse
charge"). The reverse charge has been used effectively to
counter other fraud such as fraud in the gold market, and was
the solution recommended by the CIOT in relation to consultations
on carousel fraud.
21. The CIOT considers that the reverse
charge is likely to be more effective than other measures. However,
it too has flaws. First, it will not be applied to all goods,
and no doubt other means of perpetrating the fraud will arise
using alternative goods. Second, it applies only to goods when
it is conceivable that the means of achieving similar fraud could
arise in relation to services because there are instances where
the same situation that exists under current legislation in relation
to inter-EU acquisitions also applies to services. Third, there
is some discrimination against the UK to UK trade, as will be
discussed below.
MEASURES SUGGESTED
BY THE
COMMISSION
22. The measures suggested by the Commission
are set out in a document entitled "EU coherent strategy
against fiscal fraud—Frequently asked questions" (MEMO/06/221
dated 31 May 2006).
23. The Commission advances a number of
strategies, including:
— reinforcement of existing co-operation
tools between member states and third parties;
— improvement of the exchange of information
making use of new developments in information technology; and
— possible more extensive use of the
reverse charge.
24. The document also discusses the so-called
"definitive VAT system", or taxation at origin. However,
the CIOT notes that this proposal requires considerably greater
harmonisation than at present. Many factors militate against this
as a solution, including the fact that previous attempts at harmonisation
have failed, the investment it would require by business to move
to systems capable of dealing with an origin based system and
the fact that a new system is more likely to be weak initially.
As a means of rapidly responding to current threats, therefore,
the solution is likely to fail.
25. The CIOT agrees that the solution most
likely to meet the need for immediate and effective action against
fraud is likely to comprise a combination of the use of the reverse
charge together with better information exchange. Indeed, the
emphasis should be on exploiting technology to move to a real-time
information exchange, in order to reduce the time that criminals
have to achieve their objective—a virtual "flying squad"
against tax fraud.
26. The model for the exchange of information
already exists in the systems used by credit control agencies
across the world. As discussed above, tax held by taxpayers can
be regarded as "credit" granted by the tax authorities
to taxpayers. Normal business practice is to make checks on the
creditworthiness of debtors before granting credit.
27. In a typical commercial situation, credit
limits are set on:
— the debtor based on a combination
of his credit history and other factors, eg the fact that he owns
property;
— the size of a transaction, eg a person
who tried to use his credit card to obtain, say, £100,000
credit at a restaurant is likely to find the transaction queried
even if he has an AAA rating; and
— other factors, eg a person using
a credit card extensively outside his normal place of residence
may find that the credit agency contacts him to confirm that it
is indeed he who is using the card.
28. In order to combat fraud, it needs to
be remembered that the taxpayer seldom has all the information
at his disposal to check on a customer. Further, if he is being
paid in cash or is paying in cash for goods that can be physically
identified, there is normally no incentive or commercial reason
why he should do more.
29. The tax authorities (in any country),
on the other hand, are in a position to require information and
to monitor it to determine whether or not a risk exists. Further,
if information is obtained in real time there is a greater chance
that they will in fact capture the criminals and cut the problem
off at the head.
30. Accordingly, the CIOT is in favour of
advancing better information exchange as a solution. However,
in doing so, it is important to reduce to a minimum the burdens
placed on taxpayers. A system of exchange should therefore provide
for:
— a one-stop shop at which the taxpayer
can contact the tax authorities (regardless of where the transaction
is to take place) to provide details of specified transactions
for clearance;
— clear guidance of the limits on size
of transaction (de minimis limits) where it is necessary to seek
clearance—obviously a taxpayer would not seek guidance where
he is satisfied that past dealings with the customer/supplier
make it clear that he is to be trusted;
— a commitment by the tax authorities
to real-time clearance of transactions in a time frame that does
not cause damage to business; and
— alternative procedures to deal with
situations where a transaction may result in a fraud risk, eg
an instruction to the customer to apply the reverse charge for
transactions that would otherwise not normally be subject to the
reverse charge.
31. However, overlaying whatever system
is used should be a recognition that businesses exist to make
profits and create wealth for investors, employees and other persons
in the economic chain. Accordingly, any solution must be proportionate,
and should accept the fact that a degree of tax loss is inevitable
if business is not to be strangled by regulation.
THE NEED
FOR GREATER
CO-OPERATION
32. The CIOT agrees with the Commission's
contention that organised crime is a global phenomenon and that,
accordingly, it is necessary to tackle the problem on at least
a Community-wide basis, and preferably on a global basis.
33. However, the immediate concern of the
UK should be the protection of UK tax revenues. The UK should
therefore act to introduce proportionate measures and to develop
the technology necessary to counter fraud. In doing so, it should
recognise that there are existing commercial undertakings that
have the experience and, to some extent, the systems that might
form the starting point for the information requirements.
34. While the Commission may be best placed
to bring forward a Community-wide solution, that should not prevent
co-operation with other member states or third party states who
may already be developing solutions to defeat tax fraud.
THE IMPACT
OF THE
ADOPTION OF
MEASURES TO
FIGHT COMMUNITY
FRAUD ON
NATIONAL SYSTEMS
35. It has always been recognised that the
reverse charge on acquisitions can act unfairly. This is because
a business that acquires goods from a neighbouring member state
does not have to pay VAT until such time as it makes its VAT return,
while the same business would pay VAT if it bought from a local
business. This probably does not affect the UK to the same extent
as businesses in areas where there are many borders, such as in
the smaller European countries.
36. If the reverse charge were applied on
a wider basis, it might in fact provide a more level playing field
in some cases. However, against this it must be remembered that,
where the reverse charge is applied, there remains some scope
for loss of the entire amount of VAT because, in cases where supplies
are ultimately to end-consumers, a taxpayer can use a VAT registration
to acquire goods free of charge and disappear without accounting
for VAT on any subsequent sales. This may impose a burden on the
policing of the use of the reverse charge within member states,
since it is in the member state in which final consumption takes
place that the greatest risk will fall.
37. National systems are required to be
harmonised with the EC Sixth VAT Directive and, although member
states are free to choose the arrangements they wish to make,
there are limits, as the decision of the European Court of Justice
indicated in the case of Federation of Technological Industries.
38. The imposition of specific invoicing
requirements by the "Invoicing Directive" did not appear
unduly to burden member states who had to harmonise their systems,
largely because the requirements were restricted mainly to information
that a business would normally put on an invoice anyway. There
does not appear to be any reason why sensible, well thought-out
measures should not accord with normal business practice, and
so avoid creating any new problems with the policing of VAT.
22 September 2006
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