Memorandum by Dr Michael Cheetham
My company Bond House Systems was one of the
largest computer component distributors in the UK. We had been
trading for approximately 10 years and had just been appointed
an official AMD reseller for the UK when the might of HMRC descended
upon us in a creative and novel approach to try and find a solution
to the MTIC problem. As Customs own policy papers now show, that
solution was to crush the export companies and deprive them of
their cashflow in an effort to strangle the entire affected trade
sectors. That Policy has continued to this day in one guise or
another and as the trade and loss figures show it simply has not
worked (apart from it being wholly illegal).
In 2002 HMRC sought to solve the growing MTIC
problem by suspending the VAT repayments to legitimate trading
companies such as mine and the fight went all the way to the European
Court of Justice who declared the action unlawful. The litigation
has reached a successful conclusion now and I would not wish to
waste the valuable time of the Select Committee with my plight.
It is far more important to look towards the future and to sort
this problem out so that this country stops losing the £3-8
billion and legitimate companies trade can trade once again free
from the Armageddon that is no been inflicted on them in an effort
to suppress the high percentage of illegitimate companies and
those that are just milking the system.
For the last four years, I have developed and
refined a near perfect solution to the EC MTIC problem and the
litigation between my company and HMRC has prevented me from being
able to present this to HMRC. Over the last three years, we have
been unable to meet on three separate occasions and sadly the
UK may well have lost over £10 billion in that period that
I may well have been able to prevent. Despite being a simple and
clear concept to understand, it is highly effective and could
be implemented at either UK or European level without any further
legislation. It would not however function if reverse charging
was introduced indeed there would be no need for it.
Reverse charging is not however without its
problems. It will create two entirely new frauds—end seller
fraud and end user fraud. End seller fraud will be where the trader
will receive the goods from an "RÇ vat free chain
and will sell to the public (eg on EBAY), charging the VAT as
prescribed but either pretending to have sold the goods VAT free
onto another RC company or simply go missing with the VAT. Using
the 17.5 per cent VAT, this end seller fraudster will be able
to discount the price (say 7.5 per cent) to make the goods attractive
to the public and retaining the extra 10 per cent for themselves.
Whilst end seller fraud does not have the same perpetual capacity
to grow as carousel fraud, it is much harder to detect because
this time the fraudster is located at the fat end of the wedge.
Legitimate companies selling to the public on the High Street
eg Carphone Warehouse will not be able to compete against the
End Seller fraudster with their 17.5 per cent margin to play with.
"End User" fraud is another problem
where people will pretend to be VAT registered to secure goods
at VAT free prices when in fact they are not VAT registered at
all. This may grow into a small but significant problem. Once
again this fraud is located at the fat end of the wedge and its
detection all the more difficult to undertake.
The biggest problem with Reverse Charging is
that the UK is in reality saying to the EU ... Please can we have
a special permission to rid ourselves of the problem by having
no VAT in these supply chains and we will "dump" our
problems on you. At present, most of the organised crime setting
up and running the Missing Trader companies are domiciled in places
like Dubai, Switzerland and the Far East. If the UK is granted
the Derogation these people will simply come to the UK to operate.
Why send the goods three days to Dubai, one day there and then
three days back ie a seven day turn of the Carousel when you can
operate the fraud from the UK and do 10 frauds in a day.
The goods will pass from a missing trader chain
in France, to the UK traders who will then sell the goods to a
Missing Trader chain in Slovakia who will sell them back to the
UK who will then sell them to Germany and so on.
What is so important to understand About Reverse
Charging (RC) is that an anomaly of the VAT system called "Triangulation"
or Article 22(8) means that goods can actually pass from the Missing
Traders in France, directly to those in Germany. There is no need
for the goods to come to the UK and the UK simply handles the
paperwork (invoices) and the payments. Article 22(8) is a perfectly
correct and normal trading system that will be exploited by those
who will come to the UK to mastermind the fraud in other member
states from here.
The UK will simply put up its hands and say
"we don't have a problem because we don't have VAT anymore
so we don't have the fraud" and meanwhile we inflict the
fraud on an accelerated scale on every other EU state. Do we really
want to propose this as a solution?
The final and equally important problem with
the RC derogation as it stands is that it covers only a small
range of high value commodities. The fraudsters are highly experienced
and now educated and throughout the last 10 years they have sought
to counter and avoid whatever tactics HMRC have sought to try
and enforce. The fraudsters simple solution to RC is to move into
other goods and services. I am already receiving many reports
regarding the emerging problems in the pharmaceutical sectors
(high value drugs), medical equipment, plasma TVs, children clothing
and even sugar.
It will not be possible to return to the EC
and ask for a never ending list of products to be added onto the
provisions. The fraud will be displaced into other goods and that
is all. The solution that I offer takes this into account and
does not require derogation of any kind. It can be implemented
nearly immediately.
I have termed a second solution which would
prove an effective solution certainly for the UK and the vast
majority of other EU members "Base Rating".
BASE RATING
The MTIC problem is a very simple one at its
heart and no matter how complex the fraudsters schemes, cloaks,
diversions and counter measures become, the fraud occurs because
goods are zero rated between EU member states. That is it. That
is all that matters. If you stop this. You stop the fraud.
The fraudster usually drop the price down (using
the VAT margin) to at or below market prices to catalyse the sale
of the goods by making them attractive to purchase.
The current VAT systems was always intended
to be a temporary one and in its early days of development the
options of "point of origin" tax or "harmonisation"
were explored. I will deal briefly with the problems of these
and why they were not adopted during the infancy of the EU VAT
system.
Point of Origin Tax
This involves paying the VAT of the EU suppliers
country and then being able to offset this tax against UK sales
as input tax.
The current VAT rates in the European Union
|
| Standard Rate
| Food Rate |
|
| Austria | 20
| 10 |
| Belgium | 21
| 6 |
| Denmark | 25
| 25 |
| Finland | 22
| 17 |
| France | 19.6
| 5.5 |
| Germany | 16
| 7 |
| Greece | 18
| 8 |
| Ireland | 21
| 0 |
| Italy | 20
| 4 |
| Luxembourg | 15
| 3 |
| Netherlands | 19
| 6 |
| Portugal | 19
| 5 |
| Spain | 16
| 4 |
| Sweden | 25
| 12 |
| United Kingdom | 17.5
| 0 |
|
Thus a VAT registered UK trader purchasing from Germany would
buy a net £100 item at £100 + £16 (VAT)—Total
£116. If he sold this in the UK, for £102 net (2 per
cent profit margin), he would then charge £102 + £17.85
(VAT)—Total £119.85.
The UK VAT return would reflect these two VAT amounts (an
EU input tax and UK output tax) on his VAT return and the UK Trader
would required to account for the difference of the VAT, in this
example pay £1.85 to the UK government.
The major problem with point of origin tax is that it penalises
intra EC trade against those member states with higher VAT rates
than the purchasing country. Why would a trader want to purchase
from Denmark goods with a 25 per cent VAT uplift on them when
the same goods could be purchased for a similar price at 15 per
cent VAT from Luxembourg. The 10 per cent difference in cashflow
is of massive significance to a trader, especially as they may
have to wait up to three months for a refund if the VAT imbalance
is negative.
It is interesting to note that many internet companies have
now chosen to base themselves financially in Luxembourg (selling
to end users and thus charging full VAT of the country of origin)
in order to charge the public 15 per cent end user VAT. This trade
displacement effect would be amplified on a massive scale were
Point of Origin tax to be introduced EU wide.
It was decided that this system would severely penalise the
higher rate countries and so it never got any further. I do note
that it is once again being considered by the European Commission
as a possible MTIC solution.
My solution of "base rating" deals adequately with
this shortcoming.
The second problem with Point of Origin tax is that it requires
the individual EU member states to make necessary adjustments
to tax volumes collected based on EC Sales and Intrastat figures.
Any imbalance on intra EC sales tax collected must be adjusted
at regular intervals. This is heavily reliant on the intrastat
and EC sales being very accurate and up to date. Historically
these collected statistics have been shown to be grossly incorrect,
late and with a huge variation of controls and enforcement across
the EU states. One can imagine Italy objecting to refund the UK
any tax imbalance because their EC sales figures do not match
ours or one of the newer EC member states (still coming to grasp
with Intrastat) not being ready in time for the balancing deadlines.
The fiscal adjustments are based on:
1. the differential between individual volumes of the
two-way trade between those two member states; and
2. the differential between those two countries VAT rates.
My solution of "base rating" reduces this problem
but does not deal with it entirely.
Harmonisation
Once again, an easy concept and it was hoped in the early
days that all EU members would adopt a single rate of VAT across
Europe. At many of my lectures, it is one of the first solutions
that audience members raise as a realistic solution. The problems
of this are nearly too obvious for me to bother typing to you.
Denmark and Sweden at 25 per cent are hardly likely to give up
the extra revenue they receive now if they are asked to drop their
rates to a more central EU wide 18 per cent. The government would
take a 7 per cent drop in revenue from VAT overnight. Can you
imagine the objections from the Electorate in Spain if VAT was
put up to 19 per cent just to facilitate intra EC trade without
MTIC problems. An immediate 3 per cent uplift in inflationary
terms, just to solve MTIC.
BASE RATING
This is my simplest solution to the MTIC problem. Instead
of goods passing between VAT registered traders at 0 per cent
VAT which facilitates the fraud, why not pass between member states
at the lowest rate of any EU member ie 15 per cent.
Thus a £100 net sale from the UK to Germany would be
£100 + £15 VAT. Between Italy and France the same €100
+ €15 VAT. 15 per cent would be charged everywhere on intra
EC sales or whatever the lowest VAT rate was within the EU. At
present, I am not sure what rates Bulgaria or Romania intend to
bring to charge next year.
There would be no imbalance in cashflow because the goods
would be charged at the same rate across the EU and intra EC trade
would be driven on a level VAT playing field by market prices
and not VAT impaired cashflow.
The margin for MTIC fraud would be drastically reduced in
most member states because based on 15 per cent base rate, goods
sold in the UK at 17.5 per cent (so a maximum of 2.5 per cent
for a potential fraudster) would leave no margin for the fraudster
to either drop the price or make any profit themselves. Since
legitimate traders normally expect a 2-4 per cent margin on their
sales, the marketplace would not be receptive to the fraudsters
goods and even if one sale did take place (in the EU members with
much higher VAT rates), there would not be sufficient margins
to make the carousels that we see nowadays turn a single revolution.
In the majority of member states such as the UK, a 15 per
cent base rating of all intra EC sales (rather than the current
0 per cent) would see the fraud unable to operate. In those member
states with the higher rates eg 25 per cent, their exposure would
be significantly less ie 10 per cent.
Financial adjustments between member states would still need
to take place monthly or quarterly to correct any imbalance in
tax collected but in my concept of base rating this would simply
be based on the differential between two way trade of those two
countries. If German suppliers had sold £20 billion worth
of VAT goods to the UK and the UK had sold £15 billion to
Germany then the VAT adjustment would need to be refunded on the
£5 billion imbalance.
These kind of adjustments already take place between EU members
states on duty matters and the EC sales and Intrastat would provide
the raw data on which these adjustments could be made.
"Base Rating" is so simple to define and introduce.
One simply replaces the words "Zero rating on EC sales"
throughout the Sixth VAT Directive with "Base Rating on EC
sales" and defines "Base rating" as the lowest
rate of any member state.
Base Rating was the first solution that I devised and until
four years ago, it was the best. It was in 2002 during a trip
to the USA that I saw a very clever solution to tackle cross border
fraud between Mexico and California This led to the development
of my second solution that I now call VLN. The fraud cannot operate
and unlike the current HMRC tactics, it doesn't suppress legitimate
trade.
It would stop the fraud overnight and would work perfectly
in the UK alone but would be absolute if introduced EU wide. It
will work with any commodity unlike the derogation that has a
limited range of products that it covers. I am sure the fraudsters
already have a new list of products to exploit if reverse charging
is applied essentially to chips and phones.
22 January 2007
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