Memorandum by HM Treasury and HM Revenue
and Customs
Q1. What is the exact nature of VAT Carousel
Fraud?
Missing Trader Intra-Community (MTIC) VAT fraud
is an organised criminal attack on the VAT system, which is estimated
to have cost the UK exchequer between £1.1 billion and £1.9
billion in stolen VAT revenues in 2004-05. Its simplest form—known
as acquisition fraud—involves obtaining a VAT registration
number in one Member State for the purposes of purchasing goods
free from VAT in another EU Member State, selling those goods
at a VAT-inclusive purchase price in the UK and then going missing
or defaulting without paying the VAT due to HMRC.
A more abusive form of the fraud—known
as carousel fraud—involves the same goods being traded around
contrived supply chains within the EU, and re-entering the UK
on a number of occasions with VAT being stolen each time. A simple
example is:
— Company A in another Member State
sells goods VAT free to a UK company B.
— Company B sells the goods VAT inclusive
to another UK company C.
— Company B should pay the VAT it has
charged on the goods to HMRC, but fails to do so. Instead they
go missing, or default on the payment.
— Company C sells the goods VAT free
to an EU or third country company, which could be company A (hence
the term "carousel"). Company C claims the VAT it has
been charged by company B from HMRC.
The fraud occurs when company B does not pay
the VAT, and the tax loss crystallises when company C claims a
VAT repayment from HMRC. In practice the fraudsters complicate
this model by inserting a number of other companies in contrived
transaction chains between companies B and C, and routing the
goods out of the EU. In the UK the goods most commonly associated
with this fraud are mobile phones and computer chips, but other
(particularly electronic) goods have also been targeted recently.
Q2. Are there gaps in legislation which allow
this form of fraud?
EU VAT law is set out in the Sixth VAT Directive
(Directive 77/388). This legislation is clear that sales between
registered traders in different Member States are normally VAT
free, and VAT is charged on subsequent sales within the Member
State. The fraudsters exploit these rules by charging VAT and
illegally failing to pay it over to the Government, while abusing
the right to deduct VAT on their purchases. MTIC fraud therefore
does not occur because of gaps in legislation, rather it involves
criminal breaches and abuses of the law.
Q3. What impact does this fraud have on the
internal market?
Simple acquisition fraud can lead to market
distortions because the fraudster, who has no intention of paying
VAT, is able to undercut legitimate businesses trading in the
affected markets. Carousel fraud often involves over-valued supplies,
but the impact on the legitimate markets for the goods involved
is relatively small because of the closed nature of the contrived
transaction chains operated by the fraudsters. However, the very
scale of the fraud can damage public finances, distort trade statistics,
and disrupt the timely delivery of new products to the retail
market. Whilst many Member States do not publish the scale of
losses in their particular jurisdictions, MTIC fraud is recognised
as a common problem and it is clear that losses from this type
of fraud are experienced throughout the EU.
Q4. What are the measures currently applied
to combat this fraud and what are their weaknesses?
HMRC's strategy for tackling MTIC fraud has been
in place since September 2000. It aims:
— to stop the fraud before it can begin
through risk based controls to identify bogus businesses and refuse
to register them for VAT purposes;
— where fraudulent trading begins,
to identify and stop it at the earliest opportunity—by operating
close audit and verification controls on suspect businesses and
those trading in affected sectors; and
— where it cannot be stopped, to disrupt
the fraud—by tackling all points of the supply chains and
using the full range of criminal and civil measures available
to target those orchestrating and/or facilitating the fraud. HMRC
works closely with UK agencies and overseas agencies to identify
and target suspect trading and money flows.
As the patterns of fraud have changed, HMRC
has adapted and strengthened its MTIC strategy accordingly, key
changes being:
— redeploying almost 600 additional
compliance officers to verify repayment claims submitted by those
trading in suspect supply chains;
— strengthened international co-operation
both with EU Member States and with non-EU countries;
— introducing legislative measures
in this year's Finance Act to clarify and strengthen UK powers
to tackle MTIC fraud; and
— applying to the European Commission
for a derogation to introduce a reverse charge accounting procedure
for the goods most commonly used in MTIC fraud.
The reverse charge would effectively remove
the physical payment and repayment of VAT from business-to-business
transactions, thus removing the opportunity to steal VAT. The
derogation is subject to adoption by the Commission and Council.
Based on current progress with the derogation process, HMG expects
to implement the reverse charge on 1 December 2006.
The main challenges for HMRC's strategy are
the speed with which the fraudsters can change their tactics in
response to HMRC interventions, and their ability to disguise
their activities to resemble legitimate trading. This requires
HMRC's strategy to be very flexible, finding a balance between
effectively targeting the relatively small number of fraudsters,
while minimising the impact of that activity on the vast majority
of the 1.8 million VAT registered businesses who trade legitimately
within the UK, and acting within the constraints of EU and UK
law.
Having good and timely intelligence about those
involved in the fraud and their tactics is the key to getting
this balance right. It is important for the UK to continue to
share intelligence and work with our EU partners to tackle the
fraud.
Q5. Are the mechanisms suggested by the Commission
to fight this fraud adequate?
The Commission has advocated several approaches
to combating carousel fraud, from strengthening existing practices
regarding mutual assistance, to more fundamental changes to the
VAT system, which could involve either a move to the Origin system,
a reverse charge option, or a single rate of taxation for intra-community
trade.
The recommendation to improve EU mutual assistance
is to be welcomed. This would be achieved at a number of levels,
including improvements to the IT infrastructure to exchange information
and better application of procedures contained in existing legislation
that are currently under-resourced. The Commission has prepared
provisional plans to upgrade the IT infrastructure but the draft
timetable indicates delivery during the period 2009-11. The UK
is making every effort to speed up delivery.
The suggested move to an Origin system, where
VAT is charged in the Member State of the supplier, has a number
of problems. Not only could it lead to a harmonisation of VAT
rates, as businesses would relocate to the Member State with the
lowest rate of VAT, but also new fraud opportunities could be
created by the cross-border nature of the supplies. These fraud
opportunities would also arise with a single rate taxation of
intra-community trade.
The Government is interested in exploring the
technical feasibility of other legislative measures to counter
VAT fraud at the EU level, including reverse charge measures and
other options not specifically mentioned by the Commission, such
as enhancing Member States' ability to refuse repayments in cases
of fraud.
Q6. 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?
The answer to fighting carousel fraud is through
a range of solutions both domestically and at EU level. The UK
is already making progress through its package of measures, which
address the fraud throughout all the stages in the supply chain.
In addition we hope that the Commission and Council will soon
adopt a proposal which would allow the UK to derogate from Community
VAT law, and introduce a domestic reverse charge for the specific
goods targeted by the fraudsters. However we also welcome the
Communication from the Commission on VAT fraud and support many
of the measures suggested, in particular the need to improve mutual
administrative assistance. Whilst we would not be in favour of
all of the policy responses suggested in the Commission's Communication,
we welcome the opportunity to discuss these issues, including
how to strengthen the ability of Member States to combat fraud
through changes to the Sixth Directive and improvements in the
practical application of existing legislation where co-ordinated
action is required.
Q7. Does the adoption of measures to fight
VAT fraud at the Community Level undermine Member States' control
over the functioning of National Fiscal Systems?
The majority of measures suggested by the Commission
would improve Community legislation and procedures that would
support and enhance the ability of Member States to combat fraud.
The UK will oppose any move to the Origin system that would undermine
the basis of VAT as a consumption tax and will look carefully
at all suggested solutions to ensure that they do not undermine
the functioning of national systems.
21 September 2006
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