Memorandum by PricewaterhouseCoopers
PricewaterhouseCoopers LLP ("PwÇ)
is pleased to submit evidence to the UK Parliament European Union
Committee inquiry into carousel fraud in the EU. PwC fully supports
all effective and proportionate steps taken by any body to tackle
this fraud. PwC has taken active steps in order to ensure that
it does not engage with organisations that may be involved in
carousel fraud, including additional client acceptance procedures
for clients in industries where carousel fraud is thought to be
concentrated.
INTRODUCTION: THE
NATURE OF
THE FRAUD
Carousel fraud derives from two key features
of the EU VAT system:
1. A VAT registered business can purchase
goods from a business elsewhere in the EU without the need to
pay VAT to the supplier. Instead, VAT is accounted for through
"acquisition accounting" that requires the purchaser
to account for the VAT through entries on its VAT return.
2. A VAT registered business that sells goods
to another customer in the same EU member state collects VAT from
the customer and should remit this VAT to the local tax authority.
The VAT registered business is in effect acting as a tax collection
agent of the tax authority.
These two features combine to allow a business
to purchase goods without a requirement to pay VAT, and to then
sell those goods and collect VAT from its customer. Legitimate
businesses remit that VAT cash amount to the tax authorities,
whereas fraudulent businesses "disappear" without paying
that VAT to the tax authorities. A number of variations of the
fraud have developed, all of which rely on these two features.
However, it should also be noted that businesses
that purchase goods from domestic suppliers and sell those goods
to domestic customers could also perpetrate the fraud by relying
only on the second characteristic above and by not declaring (or
underdeclaring) VAT on sales revenue. However, it is the combination
of the characteristics above that creates the ability to generate
large amounts of fraudulent funds in a relatively short period
of time.
ARE THERE
FLAWS IN
THE LEGISLATION?
The VAT system is designed to collect tax on
the value added by each participant on the supply chain, and there
is a reliance on each participant in the supply chain to collect
tax and remit this to the tax authorities. It could be argued
that this reliance on taxpayers to assess and collect tax is a
fundamental flaw in the system. PwC does not agree with this analysis,
because many tax systems, including personal and corporation taxes
in the UK, rely on similar self assessment and payment by taxpayers.
With carousel fraud, the VAT system can in itself
be the reason why a transaction takes place. Carousel fraud provides
an incentive for criminals to enter into specific transactions
with the sole intention of collecting VAT that will not be remitted
to the tax authorities, generating cash that can then be misappropriated.
This suggests that there are two approaches
that could successfully combat this fraud:
— increased control over those businesses
that are VAT registered and that currently have a right to collect
VAT on behalf of the tax authorities; and
— eliminating the ability of VAT registered
businesses to collect VAT on behalf of the tax authorities.
IMPACT ON
THE INTERNAL
MARKET
Carousel fraud has led to a number of outcomes
that have a negative impact on the efficiency of the economy,
including:
— Extra administrative burdens are
created for both businesses and the tax authorities who have to
develop and implement procedures designed to combat carousel fraud.
— Legitimate businesses may suffer
through delays in receiving VAT repayments.
— The fraud may create transactions
that have no economic benefit, and exist only to create the conditions
necessary for a fraudulent trader to collect VAT and misappropriate
this.
These wider economic impacts, in addition to
the misappropriation of government funds, create compelling reasons
for the development of policies that will effectively deal with
carousel fraud.
THE UK'S
MEASURES TO
COMBAT CAROUSEL
FRAUD
(1) HMRC in the UK have attempted to place increased
controls over businesses that collect VAT. This has extended to
undertaking detailed investigations of businesses involved in
certain industry sectors and withholding repayments of VAT from
traders.
It is the view of PwC that this action has been
disproportionate in that it has impacted substantial numbers of
businesses that have no involvement with carousel fraud. In saying
this, we are fully aware of the scale of the problem HMRC is facing
and we agree with the principle of HMRC carrying out checks. The
cash flow impact of withholding VAT repayments has led to a number
of businesses ceasing to trade, and the legitimacy of the legislation
adopted in the UK and the approach of HMRC has successfully been
challenged in the courts.
The issue is how long HMRC will continue to
withhold their repayments and if, in the meantime, innocent companies
may be liquidated due to the time being taken to verify supply
chains.
If a trader has taken reasonable steps, including
due diligence checks on his suppliers and customers, and has procedures
in place for his own records to demonstrate he is taking every
precaution which could reasonably be required of him, it follows
that even if he is unwittingly part of a fraudulent supply chain,
with the above in mind, HMRC should be repaying his input tax.
However, the current actions by HMRC do not allow for traders
to have their systems and processes taken into consideration and
consequently all traders are being treated the same regardless
of their intentions.
It would be helpful if HMRC could consider a
more targeted and objective approach to the current wholesale
withholding of input tax to enable more dialogue between HMRC
and affected traders who wish to continue in business for legitimate
reasons. Until this approach is adopted we believe many businesses
will be forced into legal action through judicial reviews which
not only take time but also cost significant sums of money.
(2) Legislation was adopted in the Finance
Act 2003 amending paragraph 4 of Schedule 11 of the VAT Act 1994
to combat VAT fraud. It gave powers to HMRC to seek security with
regard to payment of VAT credits and gave ambiguous scope to the
information that HMRC could seek from the taxpayer. 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 ...".
This outcome creates a serious difficulty to
using this legislation effectively because it creates a subjective
test in order to establish whether a business has an entitlement
to recover VAT. A subjective test means that disputes are more
likely to arise due to differences in opinion between taxpayers
and the tax authorities in relation to what should and could have
been known at the time of the transaction. PWC is aware that HMRC
have used this issue in order to continue to block VAT repayments
for some traders.
We have also noted instances where HMRC have
been reluctant to provide businesses with any certainty that checks
that are voluntarily performed by a business on its supply chain
will provide a measure of protection from the actions of HMRC,
and this has created frustration on the part of the large majority
of businesses that pay VAT correctly.
(3) Finance Act 2003 also introduced what
is now S77A VATA 1994. This gives HMRC power to, in effect, penalise
an innocent trader in a chain of transactions where a fraud has
taken place. PwC has always had severe reservations about the
fairness of this approach, which has of course been significantly
discredited in the Bond House/Optigen cases. We think it
unfortunate that the reverse charge route was not tried earlier.
(4) The Finance Act 2006 has introduced
measures that shift the burden of accounting for the tax to the
recipient of a supply (the "reverse charge" procedure).
This means that VAT is not physically paid to the supplier, and
so cannot be misappropriated if that supplier is fraudulent. The
reverse charge has been used to counter, effectively, VAT fraud
in other business sectors, such as fraud in the gold market. The
UK is currently awaiting permission from the EU to put the new
system into effect.
PwC considers that the reverse charge is likely
to be effective in mitigating carousel fraud because it prevents
businesses collecting VAT from suppliers, which is then at risk
of misappropriation. It is also welcome because it should not
adversely impact the businesses that are not engaged in carousel
fraud. However, PwC is of the view that there is a risk that carousel
fraud may move to be perpetrated in business sectors that are
not subject to the proposed VAT legislation. This may mean that
the legislation may have to be extended in future and in turn
raises a concern about the possible impact of frequent changes
for compliant taxpayers.
MEASURES SUGGESTED
BY THE
EU COMMISSION AND
THE ACTIONS
OF MEMBER
STATES
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.
The Commission advances a number of strategies
including:
— enhanced co-operation tools between
Member States and third parties;
— using information technology to effectively
identify and stop fraud; and
— possible more extensive use of the
reverse charge.
PwC believes that the solution most likely to
meet the needs for immediate and effective action against fraud
is the use of the reverse charge mechanism. The additional proposals
of the EU Commission will be helpful but are likely to take time
to implement, given the requirement for international agreement.
Individual member states can act within these
broad parameters in order to combat carousel fraud. The use of
a derogation from the general principles of EU VAT law, which
the measures in the UK Finance Act 2006 rely on, provide an opportunity
for member states to combat carousel fraud in the short term.
The other strategies proposed by the EU Commission also establish
a framework to tackle the fraud more effectively in the future.
This will be of assistance if, as PwC anticipates, carousel fraud
moves out of industries that have been subject to specific VAT
legislation that applies the reverse charge to other industries
that are not subject to this VAT treatment. This framework also
allows individual member states to retain control of the implementation
of national VAT systems effectively.
SUMMARY OF
PWC'S
VIEWS
As we noted at the start of this paper, PwC
fully supports all effective and proportionate steps taken by
HMRC to tackle this fraud. Over view is that the UK legislation
that has been introduced will have a significant impact on carousel
fraud. It will ensure that innocent businesses do not suffer an
economic consequence from efforts to combat carousel fraud.
We are concerned that there will be a migration
of the fraud to other business sectors, and we are concerned about
the implementation of the changes happening too quickly after
the granting of the derogation without a period of adjustment
for businesses generally.
PwC does not consider that the proposed UK legislation
will be effective in tackling all VAT fraud, of which there are
many types, but it should assist in safeguarding the UK exchequer
from the sustained attached that carousel fraud has represented
in recent years.
September 2006
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