Memorandum by The Law Society
What impact does this fraud have on the Internal
Market?
1. Fiscal fraud within the Community, depending
on which statistics are taken, is said to siphon off billions
of pounds and Euros from finance ministries. Missing Trader Intra
Community (MTIC) fraud quite simply involves a "business"
charging VAT and not accounting for the VAT to the tax authorities,
usually but not invariably, followed by another business at a
later stage in the supply chain making a claim for a VAT refund.
It is perceived to have been facilitated by the changes made to
the EU VAT system by the Single Market initiative in 1993.
VAT in overview
2. Value Added Tax (in the UK), and TVAs
in other EU countries, involves a cascade system of taxes. They
involve more taxpayers (most businesses, except those carrying
on wholly VAT exempt businesses or those under the relevant registration
threshold) as compared with sales taxes. For instance, purchase
tax, replaced in 1973 by VAT in the UK, involved only retailers.
3. One advantage to tax authorities is that
outputs or supplies made by A should tally with inputs or supplies
received by B so that in principle the trader's records should
show if transactions are being suppressed ie not declared. Another
advantage is that the VAT at stake is spread between several persons.
An example may assist:
A supplies assets to B for £100 and charges
VAT of £17.50.
B incorporates the assets into goods and sells
the goods to C for £200 and charges VAT of £35.
C, a retailer, sells the goods to the public
for £250 and charges VAT of £43.75.
The total VAT due is £43.75. However, A
accounts for £17.50; B accounts for £17.50 (£35
received from C—£17.50 paid to A); and C accounts for
£8.75 (£43.75 received from customers—£35
paid to B).
4. Other advantages of VAT include it covering
not just goods but also services and accelerating, particularly
in the case of retail sales, the time at which tax authorities
collect the tax eg the £17.50 received from A long before
C sells the goods to customers.
5. An important point to note is that if
B decided to "run off" with the VAT collected from C
the net cost to the tax authorities would be limited to £17.50
ie the difference between £35 received from C and £17.50
paid as input tax to A.
6. VAT becomes more complicated in an international
economy. For exports outside the EU, it is important that local
(eg UK) VAT is not charged as that could make goods uncompetitive
in the export territory, either if no VAT is charged on supplies
made in the country which imports the goods or local sales tax
is charged, in addition, to any VAT borne in the exporting country.
There would be little incentive for the importing country's finance
ministry giving credit for tax (eg UK VAT) paid in the exporting
country as that would reduce the importing country's tax base.
7. A similar issue arises for intra-Community
trade. So, for instance, if the UK could charge VAT on goods exported
to Germany and Germany could not charge local VAT on those goods,
Germany's tax base would reduce and the UK's increase. (Admittedly
the opposite would happen for supplies made to the UK by Germany,
but whether Germany or UK would be net worse or better off would
be difficult to predict, depending on decisions of individuals
and companies). A possible solution to this would be for all VAT
to be collected locally ("the origin system"), in this
case the UK, and VAT receipts shared among EU countries by reference
to formulae intended to take account of "export" and
"import" patterns within the Union—the so-called
"clearing house". This has not found favour with Member
States, not least because the formulae (assuming they could even
be agreed) would be difficult to change to reflect altered trading
patterns as Member States perceived reduced receipts coming into
their exchequers.
8. There is also the problem that if VAT
rates are different, eg the UK VAT rate is 17.5 per cent and German
VAT is 20 per cent, an "importer" in Germany would pay
lower VAT on UK goods than if they could buy identical German
goods on which VAT of 20 per cent was charged.
9. So intra-Community trade in goods involves
not charging local VAT in the "exporting" country and
local VAT being charged on the "acquisition" of goods
in the "importing" country. An important point, relevant
to MTIC, is that all VAT charged on supplies made in the "exporting"
country is rebated to the exporter. So, adopting the example in
2.4 above, if C "exported" the goods he would not have
to account for any VAT (ie not account for £8.75) but in
fact would be refunded £35.
10. Unlike a domestic supplier who is required
to account for net VAT (ie taking account of input and output
VAT), although an "importer" of goods who is required
to pay VAT in relation to the "import" of goods into
another Member State, that importer may not have paid that VAT
to a supplier at the time he sells the goods. (He is, however,
able to offset that VAT against output tax due on domestic sales.)
However, if he sells goods at a price which includes VAT and then
does not pay it over to the tax authorities he will disappear
with a gross amount of output tax, not a net amount which takes
account of VAT due on the "import". Again, an example
may assist.
G "imports" the goods from another
Member State for £1 million (the vendor in the other Member
State does not have to charge VAT).
G sells the goods to H for a suitably discounted
price to make the goods attractive to H, say £900,000 charging
VAT of £157,500.
G receives £1,057,500 and does not account
for the VAT of £157,500 to HMRC. The net "profit"
is £57,500.
H may then in turn sell on the goods to other
traders who all make commercial profits ie only accounting for
net amounts of VAT.
The position gets worse if, say, H is encouraged
to sell goods to a person who "exports" the goods to
another Member State as the exporter will be able to make a claim
for input tax.
So, if I offered to buy the goods from H for
£1m (and paid VAT of £175,000) to H:
H would account for net VAT of £17,500 (VAT
received from I of £175,000—£157,500 paid to G).
I would reclaim as input tax £175,000.
The net effect is that HMRC has paid out in cash
£175,000.
What are the measures currently applied in the
UK and other Member States to combat this fraud and what are their
weaknesses?
Courses of action taken in the UK
11. HMRC has tried to argue that transactions
where any party in the supply chain was fraudulent were not "supplies"
for VAT purposes. Accordingly, taxpayers could not claim input
tax recovery. This was particularly relevant to an "exporter"
which could as a result be denied recovery of VAT it had paid.
Such an approach was found to be unlawful in Optigen (Cases
C-354/03, C355/03 and C-484/03) if the taxpayers had no knowledge
and no means of knowing that a previous supplier had been fraudulent.
12. HMRC have also sought to make taxpayers
jointly and severally liable for tax unpaid by other suppliers
and to strengthen the requirements for security (against non-payment
of tax): sections 17 and 18 Finance Act 2003. Such legislation
has been partly upheld before the ECJ: see R (on the application
of the Federation of Technological Industries and others) v Customs
and Excise Commissioners.
13. The use of joint and several liability
to ensure self regulation of traders is overly burdensome. A constant
difficulty is that the authorities expect traders to undertake
line checks with their suppliers. Unfortunately the commercial
realities of legitimate traders ensure that an individual has
little opportunity to investigate his supply line beyond his immediate
supplier and the entity to which he sells on. The one organisation
that has the ability to take an overview of the entire transaction
chain is HMRC. To place a liability on a taxpayer where they are
participating in legitimate trade seems unfair and may have the
effect of inhibiting honest trade.
14. Finance Act 2006 contains provisions
which, subject to derogation being granted by Ecofin, would enable
certain types of supply to be taxed differently. Returning to
the example in 3:
A would sell goods to B for £100 on which
B (not A) would account for the tax of £17.50 to HMRC. However,
at the same time B would claim that the VAT of £17.50 was
input tax and so B would not pay any amount to HMRC.
B would normally be liable for VAT of £35
on the goods it sold to C. Instead, B would only charge £200
and C would be liable to account for the VAT on the supply made
by B to C (ie £35).
C assumed not to be supplying to other business
customers, would charge VAT on its sales of £250 ie would
collect £287.50 from its customers. C would claim that the
£35 it was due to account for in respect of B's sale to C
constituted input tax and so C's net liability was only on the
£37.50.
15. The result is that all of the VAT is
due at the end of the "supply chain". In consequence
there would be no VAT (if A were an "importer") due
from it which A could fail to account for. The liability would
pass to B who, if B sold the goods onto C, would have no net liability.
If C was an exporter then, instead of it being due a refund of
VAT already paid to B, C would have no net liability but equally
no entitlement to a refund. This is because the tax it would have
been entitled to recover on the supply from B is due to be paid
by C.
16. It will be apparent that this change
to the VAT consequences of supplies of prescribed types of goods
concentrates the risk of VAT not being paid in the end supplier
eg where C sells to non-business consumers. It does not operate
in the same way, at least as regards cashflows, as a cascade system.
17. The proposal is, however, different
to a retail sales tax insofar as taxpayers throughout the supply
chain would be required to maintain records of supplies in a broadly
similar manner to the rules applicable to conventional transactions
where the supplier accounts for VAT.
18. A concern for the taxpayers and their
advisers is whether the types of goods subject to the modified
rule will change rapidly by statutory instrument and so suppliers
may not have time to modify their accounting software. Also the
revised VAT accounting rules (ie where the purchaser accounts
for the seller's VAT) has important consequences for long-term
commercial contracts, eg whether prices charged include VAT (if
seller is responsible) or exclude VAT (if the buyer is due to
account for the VAT on the seller's supply).
Other Member States
19. It is understood that other Member States
have different proposals to deal with MTIC fraud, many of which
involve variations on the self-supply regime that HMRC wish to
adopt.
The Commission has suggested measures including
increased cross-border liaison by Tax and Law Enforcement Authorities
and Governments, improved risk management, and mutual assistance
by Member States wishing to recover unpaid taxes. Are these mechanisms
adequate?
20. On the face of it increased cross border
liaison ought to assist. Clearly where the same goods are moving
in a carousel they ought to be picked up and potential identify
fraudsters. The real issue is whether appropriate resources can
be deployed by the relevant Member States, quite often at short
notice, to deal adequately with fraudsters relatively adept at
"covering their tracks".
Are Member States, within the context of the Internal
Market and the Globalised Economy, capable of fighting individually
against this fraud or is it right for the Commission to bring
forward proposals on their behalf?
21. Clearly whether it is appropriate for
the Commission to bring forward proposals depends on whether Member
States are willing and capable to deal with an issue which, anecdotally,
is said to affect some Member States more than others. Indeed
it was reported that one reason for France not supporting the
UK's latest proposal (see 13 above) was a fear that more MTIC
would occur in France and so affect French tax receipts (see 20
below).
Is it necessary to simplify or restructure the
VAT System to prevent this type of fraud? If so, how might this
be done?
22. It is understood that the Community
is concerned about the integrity of the VAT system if widespread
changes to the system are made, and certain Member States are
said to be concerned that if the UK is given a derogation the
carousel fraud will move to those Member States.
23. One possible way of dealing with the
issue would be for VAT to be collected when goods enter a Member
State, rather than "import VAT" accounted for in the
taxpayer's first VAT return. As the "importer" would
have paid the "input VAT" he would effectively be in
the same position as a local taxpayer as the VAT paid on importation
would be tantamount to input tax. So the "importer"
would be liable to account for only a net amount of VAT to the
extent that, ignoring VAT, his selling price exceeded the "import"
price.
24. This might be perceived to be a retrograde
measure as regards the Single Market and could give rise to cashflow
(ie "import VAT" funding) costs for importers. However,
there seems to be no reason why funding to meet the VAT on importation
costs could not be available to businesses in a variety of ways
(not just commercial banks or factoring organisations). Consideration
might be given to secure areas being used to store imported goods
which did not require "import VAT" to be accounted for
until the goods left the areas, so that the time between having
to account for import VAT and expected VAT inclusive sales price
was minimised. However, extension of the concept of "bonded
warehouses" to many types of goods will necessarily give
rise to some costs.
25. There is no perfect solution to the
issue. Accordingly if decisions are to be taken at Community level,
appropriate derogations are needed as an interim measure to protect
the revenues of finance ministries. However, an obvious concern
is that the fraudsters will simply move to a different product
that does not attract the charge. Given the length of time it
took to come close to agreement on the current proposals (which
as we understand are still to come into effect) there is the prospect
that enormous revenue could be lost whilst the inherent delay
in agreeing further derogations takes place.
Does the adoption of measure to fight VAT fraud
at the Community level undermine Member States' control over the
functioning of National Fiscal Systems?
26. We are not in a position to comment
on this, which seems principally to be a political rather than
a technical issue.
What would be the benefits and costs of moving
from the current destination system to an origin system?
27. There would obviously be a need to re-programme
or re-write computer software. Taxpayers and officials would need
to be educated and appropriate publicity material prepared. There
could be downward pressure on VAT rates as a customer in the UK
faced with purchasing goods or services which (ignoring VAT) were
equally priced from the UK attracting VAT at 17½ per cent
or from a Member State charging lower or higher rates of VAT would
take the VAT cost into account. This should not be over-stated
as factors such as reliability of suppliers, currency risks, recourse
to the supplier if goods or services are not delivered or are
defective, etc will determine where orders are placed. Nevertheless,
particularly for final consumers or those unable to recover VAT
in full, differential VAT rates will be a factor which might reduce
intra-community trade.
Who are the perpetrators?
28. One issue that is not addressed by the
questions in the Call for Evidence is the common perception of
the perpetrators of this fraud. The defendants to these cases
do not often meet the public perception of "organised criminals".
Whilst enormous sums are lost through frauds of this nature, anecdotally
it appears that some defendants are often "chancers"
who happen to have identified an extremely lucrative means of
defrauding the tax payer. Specialist fraud practitioners who have
experience of handling advising defendants in cases involving
MTIC Fraud are not aware of any specific MTIC fraud whereby the
proceeds of the offending are said to entered into either terrorism
or of serious organised crime.
January 2007
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