Examination of Witnesses (Questions 200
- 218)
TUESDAY 30 JANUARY 2007
MR JOHN
ARNOLD, MR
IAN HAYES
AND MR
CHAS ROY-CHOWDHURY
Q200 Lord Giddens:
If you take these counter measures, how do you take account of
the fact that innocent people are affected? One of the articles
I read The Financial Times indicated quite difficult issues.
Mr Arnold: Perhaps I could comment on something
Lord Steinberg said earlier. There are serious problems now being
caused not only by the delays to repayments but by the VAT registration
waiting list that can stop new businesses getting registered for
up to five months while checks are made. That means, in reality,
for a small business starting up, that you can invoice but you
will not get paid until you have a VAT registration if your supplies
are to other businesses. There are two reasons for that: either
the business cannot process it without the VAT rate and everything
through its own IT system or, secondly, the business chooses not
to pay because it does not want to make an interest-free loan
to government (because it cannot reclaim the VAT). It does mean
that a start-up business, if they are unlucky enough, can be told
by the state, "Okay, but you are not going to have any income
for the first five months because that is the time it takes for
us to let you join the VAT system." It is causing all kinds
of stresses and strains on innocent businesses. We accept you
have to have checks—of course you do. We accept, if you
have a repayment claim, that you have to have checks if the figure
is out of the ordinary, but we think the delays are causing damage
to business. If they are necessary to the state for the protection
of the state, then we should be looking at ways to compensate
business whilst those delays are taking place.
Q201 Lord Giddens:
How could you resolve that? That seems to be at the structural
level. If you are going to try to do something about this then
you are bound to affect innocent traders, are you not?
Mr Arnold: We can talk about friendly fire and
collateral damage, and the Paymaster General was quoted a few
weeks ago as saying "It is better for the innocent to wait
than for the guilty to get paid" but, if the result is that
the innocent's business fails—It is a question of balance.
One can say, reasonably, maybe two weeks, maybe four weeks, but
when you start getting on to repayments for a year with nothing
you would need very good evidence as to why it is taking so long.
There may be good reasons for it, but then you say: "If it
is going to take that long, maybe we, the state, should be compensating
the taxpayer"—not by making the repayment, because
that is the point in question, but maybe we should be paying interest
as they go along.
Q202 Lord Giddens:
Maybe the economic consequences are more than the fraud.
Mr Arnold: In that case, do not hold on to the
money for so long. I am an accountant. I like to see profit and
loss accounts. I would love to see a profit and loss account of
the options, of what the real figures are, how much it is costing
business, how much it is costing the state, and then you could
take a sensible decision. At the moment we are in this kind of
fog.
Mr Hayes: There is an issue about joint and
several liability which I find difficulty with. It is something
I found difficulty with in the 2003 legislation particularly.
It comes back to this segregation of criminal from negligent,
maybe, and whether there is an issue of culpable negligence and
what should or should not a trader do in relation to his trading
relationships. I feel that if there is going to be an issue which
says that a trader is involved in a chain and has not done something
in respect of the trading relationship, either with somebody before
or after him in a chain of transactions, then is he guilty of
conspiracy. If he is guilty of conspiracy, then we were not talking
about anything other than a criminal fraud. On the other hand,
has he been merely negligent? Or maybe he has had something put
his way and he has rushed into it without doing all the checks,
crossing all the t's and dotting all the i's, and suddenly finds
himself in a very difficult situation. There is a case before
the ECJ at the moment in which the Advocate General has just delivered
an opinion, Teleos, in which some of these questions are
going to be considered, so that may well give some guidance to
this Committee in taking a view as to the issue of joint and several
liability. But at the moment it is not there.
Chairman: It interests us because we
are going to be seeing some of the people who may or may not be
innocent traders—certainly people who have cases waiting.
Lord Steinberg: I want to take up a point
that Mr Hayes made about setting up a taskforce of senior inspectors
to have a determined effort to try to get hold of some of these
Mr Bigs that we have talked about. When I was in business, which
was very recently, we used to have quite a bit of fraud occasioned
both by staff and customers. We "rattled the cage";
in other words, we got a team of people together and really clamped
down on the area where we thought a fraud had been committed.
That stopped that fraud, not permanently but for a time, and so
I was taken by what you said about getting a taskforce together.
I wonder whether it is politically possible to do so. Is there
any other country that we could look to that employs a better
system than that which we currently use in the EU? For example,
the American sales tax has been mentioned, but is there another
area to which we can look to try to replace this system which
obviously leaks like a sieve in so many areas? How does HMRC balance
the need which has been already mentioned for monitoring transactions
and not affect the normal trader?
Q203 Chairman:
Could I put a supplementary to that. At an earlier stage, in response
to Lord Steinberg's question, you suggested that the answer lay
within SOCA. Does SOCA have to be Europe-wide? We have one. Does
everybody else? It would really have to be not just us but everybody.
Mr Hayes: I do not think so. If you are looking
at criminal investigation, SOCA would be able to access Interpol
and the other anti-criminal forces in other countries. I would
probably be supportive of the idea of SOCA being tentatively extended
throughout the Commission specifically to deal with this because
that would give it the necessary powers to pursue without necessarily
the need to liaise all the time. It is the liaison that is one
of the difficulties because that takes time.
Mr Roy-Chowdhury: In terms of other avenues
to look at in terms of sales tax, the German wish for their derogation
is virtually a sales tax, so clearly it is already on the table
in a number of Member States or considered in a number of Member
States to look at other than the VAT system. Maybe, if there is
no political will to go to an origin system or a single VAT system
in Member States, we need to look at more of a sales tax type
system.
Q204 Lord Cobbold:
How big a change politically would that involve?
Mr Roy-Chowdhury: Certainly the UK had a purchase
tax. Australia had a sales tax. These things, historically, have
existed. It has been a part of the requirement to join the European
Union that everybody signs up to a VAT system because of the self-auditing
and everything else. In terms of the politics, yes, I think it
would be a big hurdle for some Member States, especially the French
who invented VAT, to go that way, but I think it is something
that needs to be in the mix. If we are not willing to get together
with other Member States and devise a single system and a harmonised
system, then perhaps we need to look at ways of dispensing with
VAT entirely as a sales tax system for the European Union.
Mr Arnold: The difficulty with a sales tax—which
is not to counter it, but there are a lot of factors one has to
look at—is, firstly, that you only have one stage of taxation,
so as a tax authority or administration your risk is with that
one business: VAT has a fractioned payment and repayment system,
so you are spreading your risk. Secondly, you need a system of
exemptions within a sales tax system, otherwise you will have
a cascade effect on business-to-business sales that are then sold
on. You end up probably with something not too different from
a VAT system in the way it is operating, although you do not have
the fractioned payments but you have exemptions. Whenever you
have exemptions, you have a tax gap, which is precisely the problem
we have now in cross-border sales. This is where you give the
opportunity for the fraud.
Q205 Lord Watson of Richmond:
I would like to stick with this sales tax question for the moment.
I was interested in your reference to the French having invented
VAT and I think that is no small matter, as a matter of fact,
because the French are really keen to hang on to what they believe
they have contributed in the first place. The streamlined sales
tax system in the United States, which I have met commercially—and
I have to say I have been rather impressed by its operation—I
would like to know your view of that particular tax and how it
is working.
Mr Arnold: It varies from state to state and
some states do not have it at all, like New Hampshire.
Q206 Lord Watson of Richmond:
Absolutely.
Mr Arnold: It applies really to goods and not
to services.
Q207 Lord Watson of Richmond:
But there is nothing inherent—
Mr Arnold: There is nothing inherent about that.
They then have the problem of cross-border supplies, which we
would have as well. They solved that in the States by having an
amnesty of no sales tax cross-border.
Q208 Lord Watson of Richmond:
Admirably pragmatic.
Mr Arnold: Admirably pragmatic but I suspect
that any chancellor would be a little reluctant to adopt that
approach here in the UK. Of course it is at significantly lower
rates in the States, anyway.
Q209 Lord Watson of Richmond:
You do not really see it as a model.
Mr Arnold: I do not personally see it as a model.
Q210 Chairman:
It involves a trusted third party intermediary?
Mr Arnold: I am afraid—
Q211 Chairman:
Does anybody have a view on this?
Mr Hayes: If one looks at what is happening
in America, you have a situation where each state determines whether
or not it has a sales tax or a tax on services—some do,
some do not. You have significant problems in the States agreeing
on how cross-border transactions shall be dealt with—a major,
major problem. If you were to change the VAT system in Europe
into a sales tax system, yes, the headline rates would have to
come down substantially to take account of the input sales tax
that would not be recoverable. I think the point John makes is
absolutely true, though, that, where you get a company like General
Motors which will manufacture in 12 different countries within
the Community and will move goods around, how does it deal with
that? That is one of the things that a VAT system does cater for.
Politically, to move to a sales tax within Europe would be far
more difficult than seeking to move to an origin system, not as
originally proposed—and I realise this is coming into another
question—but as could be modified. I note that this Committee
takes written submissions after evidence. As a result of our discussions,
we will be putting in a short paper on this to you. We are not
terribly agreed on this, I would add.
Q212 Chairman:
I do not think it matters.
Mr Hayes: There is one view, which I have, that
we should marry the VAT system far more closely to the direct
tax system within the Community. For direct taxes, if you have
Company A in the UK selling to Company B in Germany, the profit
arising on the activity of Company A is taxed in the UK; the profit
arising on the subsequent activity on those goods in Germany is
taxed in Germany with the costs from the UK being a deduction.
The fundamental problem with the origin system is that, under
the proposal, all VAT will be charged in country and there will
be no credit in the other countries. In my example, the UK would
charge VAT and there would be no credit for that in Germany, which
would mean that within the Community as a whole there would be
a need for the establishment of a clearing house system. To some
extent, that was trialled in the system that was set up for digital
supplies in respect of supplies outside the Community, and it
did not work—which is why I do not think there is much support
within the Community for some form of clearing house system and
why within the proposals for the One Stop Shop it is proposed
that payments will be made directly from the trader to the individual
company concerned. I take the view that within the system there
should be a charge for VAT as goods go from one country to the
other and that VAT rests within the country from which the charge
goes but that the country that receives it should allow a credit
against that. If I sell to you in Germany, I sell to you at £100
plus VAT at 17.5 per cent. You then, in Germany, sell on for £120
and you would charge German VAT at 19 per cent. You would allow
a credit for the UK VAT at 17.5 per cent—and I accept that
within this there is a foreign exchange issue, but I do not think
that is insuperable. In Germany you would get all the VAT attributable
to the profit element that you make in Germany. You would also
get a small margin VAT and the difference between the two rates
of VAT in Germany and the UK. If you used a supplier from Sweden
to the UK, as an example, that would work around the other way
and there would be scope for abuse by selling out from Sweden
and out of the Community and then importing into the UK so that
you do not have 25 per cent VAT charged into the UK in respect
of a supply from the UK which was 17.5 per cent.
Mr Arnold: I think that over complicates it.
Mr Hayes: Perhaps that does.
Mr Arnold: I would say that the other aspect
is that there is then no payment between the Member States. It
is just the businesses themselves which are accounting for this.
Obviously there will be controls but you would not need the clearing
house.
Mr Hayes: More particularly, the individual
transaction determines the amount of the VAT which goes into which
Member States on the basis of supply. Where we know that within
Member States transactions between countries are looked at and
are continually being looked at for transfer pricing purposes,
then there is a guarantee—or at least a degree of confidence
-that the figures that will be used are more or less going to
be commercially viable, so that you could not say that one state,
for example Germany, is going to complain that they are not getting
enough VAT. Similarly, the UK cannot complain because they have
had VAT on a bit of the transaction that relates in the UK. That
is the bones of a paper we are going to put forward to you.
Q213 Chairman:
Do you know when you are going to be able to produce this paper?
Will it be within the time of the inquiry?
Mr Hayes: When does your inquiry complete?
Q214 Chairman:
Around Easter, I think.
Mr Hayes: Certainly within the next three weeks
you will have it.
Chairman: That would be most helpful.
Between us, we have managed to ask just about everything I wanted
to ask, with the exception, Lord Jordan, of your question about
the short-term issue.
Lord Jordan: The reverse charge.
Chairman: Yes, on particular goods.
Q215 Lord Jordan:
I am hesitant to ask it because I think we are in the world of
Lewis Carroll here actually. I know that, whatever we say, there
will be another 10 outlets but it has been suggested to us that
if particular industries are targeted with reverse charge solutions
then the fraud would move to other goods. Is there evidence that
this has happened when changes have occurred before?
Mr Arnold: We are told there is evidence that
has happened and it would seem logical for it to happen. It is
why, although we proposed it—we were by no means the only
ones—in 2003, we now have a big question mark as to whether
the UK should get the derogation that it has requested. Because
if there is going to be a derogation, if there is going to be
a reverse charge procedure, we feel it should be consistent across
the whole of the European Community. We do not mind if it is the
UK reverse charge that is requested[1],
but we do not want to see different provisions in each Member
State. That makes it very difficult for business. The German reverse
charge has some logic to it in terms of combating fraud because
it goes right across the board. But, once again, it puts a high
compliance burden on all businesses because they have to file
invoice listings, et cetera. There is compliance weariness and
a feeling of over-regulation now, without adding to it. The UK
reverse charge is likely to cause a shift in the type of goods
used in the fraud, quite frankly, and there is some evidence I
have heard that it has already shifted in anticipation of the
UK getting it.
Mr Roy-Chowdhury: That is right. In southern
Europe, as I mentioned, it is these high-value vehicles and razor
blades. The shift is going to happen. One other aspect we have
not touched on, which I think is a German idea—which I do
not advocate—is where you marry up the input tax and output
tax before you make a repayment. I think that is going to be extremely
onerous on businesses. I really flag that up because we want any
proposals going forward to be business friendly. I know the Germans
did tout this idea around. It would cause extreme difficulty in
terms of cash flow and I think the IT systems as well within Member
States would not be able to cope.
Q216 Lord Jordan:
This means you cannot reclaim the input tax until you have paid
the output payment.
Mr Roy-Chowdhury: Yes. You would marry up the
transactions all the way along.
Q217 Lord Steinberg:
What do you think about my suggestion of firing a warning shot
across the bows of these criminals by rattling the cage in getting
this through? How practical is it and how quickly could it happen?
Mr Hayes: I think it is something that should
happen. I think it is desirable. I can give you an example of
a case of which I am aware. I was consulted by a firm of auditors
with a client who had turnover going from zero to about £20
million in two years. The business had not introduced any capital.
It used the Netherlands Antilles bank that I was referring to.
It had 14 transactions and it was now taking HMRC to judicial
review for the repayment of £1.5 million VAT. The balance
sheet of the company was £1.5 million, represented by £100
share capital and retained profits of £1.5 million. John
said to me yesterday, when I told him about it: "Have they
proposed a dividend?" I said, "Not yet." How much
more circumstantial evidence do you need of what is going on?
There are no price lists; payments are not made until sums are
received; all transactions go through one bank—yet that
business is not being dealt with as a criminal activity, it is
being dealt with within the tax system. That, to me, is Alice
in Wonderland.
Q218 Chairman:
It remains for me to thank you all very much. It has been a most
useful session. We look forward very much to your paper because
that will move us on. The theory tends to float above us and a
paper saying exactly how something might work would be extremely
useful to this Committee. Thank you very much.
Mr Arnold: Thank you. I am not sure how much
we have helped. But I hope—to use the quote—we have
left you "confused at a slightly higher level".
1 Note by Witness: Whilst supporting the concept
of a reverse charge as one of the temporary measures that could
help to reduce MTIC fraud until a more lasting solution is in
place, the ICAEW do not consider that the specifics of the reverse
charge requested by the UK are either proportionate or acceptable. Back
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