Examination of Witnesses (Questions 285
- 299)
TUESDAY 27 FEBRUARY 2007
MS ANGELA
O'HARA, MR
FRED HOWARTH
AND DR
MICHAEL CHEETHAM
Q285 Chairman:
Good morning, to you all, and may I in particular welcome Angela
O'Hara from Vodafone, Dr Mike Cheetham from Bond House Limited,
and Fred Howarth from the Federation of Technological Industries.
You are aware that we are looking into the question of missing
trader fraud and we would like to ask you some questions. There
are three of you so I am not going to invite each one of you for
a statement; your submissions have given us a start and our questions,
I am sure, are going to elicit the things we want to know. Can
I begin by asking all of you, what has caused your industry to
be targeted by MTIC fraudsters?
Mr Howarth: If I can begin on that, I think
our industry is typical but not unique in being targeted in as
much as we trade in high volume/high value commodities. Similarly
the pharmaceutical industry has a very similar problem; if not
as bad as our problem it is working its way towards that. So I
would say it is the value of the product we deal in and the demand
for the product.
Ms O'Hara: I think I echo those comments; it
is really high value/high volume. It is a very fast-moving consumer
goods market and I think that is really why it has been targeted.
Dr Cheetham: There was a legitimate market,
and still is, which trades in chips and phones which are such
high value. The grey market and parallel market, as it is called,
are there to find excesses of product and fill demand for product,
and it has to move very fast. If there are people building computer
systems they need the chips the next day; if there is a production
line running and it has run out of stock, those chips are needed
for the next day. Thus it is a very fast, reactive market and
this is ideal for the fraud.
Q286 Chairman:
If I might direct a question to you, Ms O'Hara, has there been
any impact on your business from extended verification and HMRC's
attempt to disrupt fraudulent trade?
Ms O'Hara: Most of our handsets are bought directly
from the Nokias and the Ericssons, so there has been really fairly
minimal disruption to us, although clearly we have put in checks
because we do not always buy from larger suppliers and it is more
internal management time. We have only had one example in the
last few years of when we were trying to assist a business downstream
to register and it took a period of six months to get that company
registered, when it wanted to recycle phones.
Dr Cheetham: Can I give an example of that.
If you take the example of Time Computers, which was one of the
biggest computer manufacturers in my region based in Burnley employing
600-800 people, and Tiny Computers based down here in the south,
they were some of the biggest computer manufacturers assembling
in the UK. They bought very large quantities of chips and hard
discs and all the computer components at competitive prices because
they are such volume buyers, if they needed 8,000 pieces they
would buy 15,000 pieces, so they would have a surplus, but because
they get such good discounts and cashbacks and so forth, they
always knew that they could sell their excess stock out into the
markets. In fact, Time Computers set up a distribution division
just to do that and towards the end, because margins in these
fields are so low, often 2, 3, 4, 5 per cent margins and these
companies are getting 20 per cent discounts, or thereabouts sometimes,
and I am sure Vodafone will tell you the figure they get, they
can prop up their businesses by selling out computer components
that they distribute. Both Time and Tiny, since Customs have started
their actions, have gone bust.
Q287 Lord Steinberg:
We are really trying to find a way of trying to put some kind
of rationale as to how we can stop this missing trader fraud,
and as we interview more and more people the situation becomes
more and more complex. Do you believe that enough is being done
from an investigative point of view when a company applies for
products from any of the organisations which you are connected
with? Do you look at their trading records, their credit worthiness,
their banks? Do you look for a history of any problems in their
background and, if so, what can you do if you find something that
you just do not feel comfortable with? Can I also ask you, in
your experience, whether you have had many problems where genuine
traders are practically put out of business because they have
claimed the VAT back but, because of Revenue & Customs uncertainty
as to which is genuine and which is not, Revenue & Customs
are holding up payments in a great many cases? Finally, what would
you do to try and stop this carousel fraud, because this Committee
is determined to try and find a way of stopping this fraud which
is costing billions and billions—not only in Britain but
throughout most of the world?
Mr Howarth: That is a very long question—
Q288 Lord Steinberg:
Several, sorry.
Mr Howarth: The first part is generally dealt
with within the industry under the heading of due diligence. Now
our industry is no different to any other within the UK or within
the EU in as much as honest legitimate traders need to establish
proper professional relationships with their suppliers; they need
to ensure they are knowledgeable in the industry, knowledgeable
of the products and run a proper business. Now, at the moment
within the UK, whether the traders are legitimate or not, and
it is very difficult to discern, the level of due diligence being
required by HMRC is almost endless. They seem to have an insatiable
appetite for due diligence and no matter how diligent a trader
is they are still experiencing extended verification. Now, there
are many companies out there, members of the FTI included, who
are on the verge of going into liquidation or who have gone into
liquidation or are taking professional advice about ways to protect
their investments. Many out there have houses which are mortgaged,
loans, family loans and business loans, which are now causing
them serious problems. We are not just talking about traders who
have been trading three or four months but traders who have been
trading for 18/20 years. Again, and I have proof of this, these
traders similarly have not had the legal certainty of trading
within the UK and being able to reclaim any VAT due to them, and
this has gone on now for in excess of a year. During that period
of time, if you withhold company's capital for in excess of a
year, it is not unreasonable to expect those companies will eventually
hit financial hardship, and that is where the majority of companies
are now. The majority of companies right now are in a situation
where, should the extended verification stop with a negative decision
on whatever basis, they will not be able to defend themselves
or appeal those decisions, which is a very sorry state of affairs
for these companies to have got into. How do you solve carousel
fraud? It is a case of working together. HMRC need to establish
a relationship with new registrations. Putting them through verification
at the registration process for six, nine, 12 months is disruptive;
it affects other businesses—not necessarily in our industry,
there is a knock-on effect down the line. Proper guidelines should
be introduced to ensure that when a new registration application
is received it is looked into by a professional who can establish
whether or not there is a business plan, whether or not there
is an intention to trade. Also, the relationship should continue.
Why, when you eventually give them registration, give them three
months' grace before they have to account for the VAT? The VAT
should be accounted for on a monthly basis automatically until
that company passes a series of tests laid down by HMRC to show
they are trading professionally, they are accounting for the VAT,
and they are a legitimate business. That relationship between
HMRC and the trader then should continue to ensure that the VAT
which is being collected for HMRC by the trader is accounted for
properly and accurately at all stages. So it is assistance that
these traders require and similarly at the other end of the chain
on the export side. Instead of coming after the event and criticising
due diligence, when a trader will sit down with the Customs officer
at an inspection stage and ask certain questions and get zero
answers: "Is it OK to trade with this supplier? Do you know
of any problems with this supplier?" and there is no answer
provided, then you go through extended verification and suddenly
they start coming up with questions: "What about this supplier?
We know of difficulties", so there is no exchange of information
within the industry and HMRC. The FTI have tried on several occasions
to open a dialogue and have failed, with basically very bland
cut and paste answers to very valid important questions from our
industry.
Ms O'Hara: As a large business obviously we
are aware of the extended verification checks and delays in people
getting repayments, but they do not affect us directly so my comments
would be broadly what we have witnessed, and there do seem to
be very significant and unreasonable delays. For example, if we
want to trade with somebody in the grey market it will not take
us six, nine, twelve months to verify that business, it would
be a much shorter period, so it does seem these delays are unreasonably
long perhaps due to lack of resources that HMRC is prepared to
put to them, and certainly it seems unreasonable to delay repayments
for six, nine, twelve months as well. Legitimate businesses should
be entitled to get their VAT back in a reasonable time. One of
the points we have tried to make to HMRC is VAT number validation.
At the moment all you can do is get them to agree that this is
a valid VAT registration number and certainly, on the comments
made by Mr Howarth, you ought to be able to give the details of
the organisation, the name and address, and get HMRC to confirm
that, and at the moment they are not willing to do that. I do
think there should be more open exchange of information.
Q289 Lord Steinberg:
Mr Howarth, you mentioned in response to my long question, for
which I apologise, two different categories, one was 17-18 years'
trading and others three or four months' trading. Now, having
been in business all my life, I would assume that somebody who
has been trading for 17 or 18 years has probably got a pretty
unblemished career and, therefore, they should not be figuring
in the hold-up of repayments, whereas the new traders, which you
said of three or four months, surely are the ones that are likely
to have the problems attached to them, and they are the ones that
HMRC should be concentrating on and raise queries on because,
from what we understand, carousel fraud and missing trader fraud,
whilst it is not new, it is not 17 or 18 years old.
Mr Howarth: One would think that if one was
to apply common sense then your comments are perfectly accurate.
However, somebody who has been trading for 17 or 18 years will
have had weddings and funerals during that time of trading, will
have survived those, will be an experienced weathered veteran
of industry, and one would think they would not be caught up in
this extended verification. However, although we are assured during
every conversation with HMRC that there is a selection process
and only companies which get flagged up on their selection process
experience extended verification, it is our knowledge that there
have been no repayments to any trader in a repayment situation
within our industry since March of last year. Some traders have
gone further than March of last year. Some will tell you they
started in December 2005, some in August, some in March 2005,
so they are the stragglers, so some have been experiencing this
problem since March 2005 and we are now into March 2007. The majority
when the policy kicked in 100 per cent was March 2006, so anybody
trading from then onwards has been caught up in extended verification.
So whether they are indicators of fraud meter moving slightly
I do not know, but they certainly managed to pull everybody up
on their selection process.
Q290 Chairman:
Dr Cheetham, do you want to add anything?
Dr Cheetham: If I talk about due diligence,
first of all, and cite an example which I have seen first hand,
2002 was when this really started from Customs. If you look at
their own policy papers, which I have seen many times and I am
happy to provide the Committee with a copy of these, there is
a classic statement in there. Prior to 2002 what Customs did was
they worked closely with the traders and set up special teams
in Redhill and Staines to try and police the supply chains and
remove the bad people. That was the promise made to the traders
at the time. But unfortunately their VAT registration checks and
these chain-of-supply checks were not working, so in 2002 you
see this tremendous shift in Customs from working with legitimate
companies to attacking them. In my day when my company was one
of the first to be attacked by Customs, the policy papers we saw
said: "We need to tackle the real cause of the problem, the
exporters. Denying them their repayment will solve this problem".
That is in Customs' policy papers. They started on my company
and that was called a verification exercise. Then obviously we
won in the European Court of Justice and there was a lull in Customs
activity. Then came the Kittel decision, which was a Belgian
case. What this decision said is that where a company has shown
that the company did know, in this case a conspirator, or should
have known, then Customs can deny their import tax potentially.
Now, this is what Customs are playing with, and the instruction
has come out from Customs, there is no doubt about it, that they
are going to stop every single repayment in chips and phones.
I understand between 800 and 1,200 VAT repayments have been stopped,
so they have moved from disruption to destruction and really at
the moment it is Armageddon. Customs only way to solve this problem
at the moment is to wipe these trade sectors totally out. They
do not care about innocent or legitimate. I did a presentation
three weeks ago to the board of HMRC on my solutions, and they
did not deny it, because their only solution at the moment is
to wipe it out. On due diligence, because you ask about that,
when joint and several liability was first proposed Customs officers
were issued with a 27-page questionnaire. They came out to visit
a friend of mine and they asked all questions about what checks
he did, barcodes, all these things, 27 pages, and at the end of
it he said: "How did I do?" And the officer said: "You
are not here to do well. We are here now to find out a weakness
in your system because if there is something you are not doing
it will stay on your file and that will be used against you should
we find missing traders in your chain of supply." Three days
later the officer came back with a supplemental list of questions
and my friend said: "Why have you come back? I must have
done OK in the first questions", and this set of questions
was about third party information that you could not commercially
obtain, and as Fred said, due diligence is an ever moving target;
even two weeks ago Customs issued a new list of things that they
want. But let's not forget, in some of these 800 companies that
have had their VAT stopped the due diligence is extreme. I have
seen a company in the last two weeks which not only did checks
beyond what you can imagine but they must have had a full-time
person working on this, but they photographed the directors of
their suppliers, they photographed the directors' houses, they
had copies of their VAT returns and their VAT ledgers but without
the company name on it—it was phenomenal. They have been
assessed for having the means to know. What Customs have cited
in that assessment is that, firstly, the company has been trading
for over 10 years and therefore it must have known, and, secondly,
that the due diligence checks were so extreme that clearly they
were suspicious that there might be missing traders in the chain
of supply. So you are damned if you do and damned if you do not.
Chairman: I think your point has been
well and strongly made. Lord Maclennan?
Q291 Lord Maclennan of Rogart:
I have understood criticisms of the present method of dealing
with the problem of this, and how it impacts adversely on the
trades. What I am not so clear about, and this is a rather general
question, is what you believe would be the more appropriate route
for the authorities to pursue. I noted, Mr Howarth, in your letter
to us that you spoke of three other countries in the European
Union, Netherlands, Germany and Denmark, having a "more targeted
approach of hounding the missing traders and prosecuting them".
What do they do that you think is better than what is done in
this country, and have you made any recommendations to the authorities
here that those particular steps should be taken?
Mr Howarth: I think those countries are using
the tools which are available to HMRC but they are making better
use of joint and several liability. They are implementing joint
and several liability whereas although HMRC have joint and several
liability it was challenged, the challenge was not successful
and it failed on a majority of points. It was successful on one
small point but joint and several liability is there, accepted
by the industry but never implemented by HMRC. Joint and several
liability tends to target the problem which is at the fraudulent
end of the chain as opposed to extended verification, which stops
legitimate traders' funds and theoretically stops the fraudsters
from committing the fraud. It does not stop them moving on but
there has been no attempt to actually catch the fraudsters. Working
closely with the industry, reverse charge are other options. These
are tools which specifically stop the fraud; they work against
the fraud.
Q292 Lord Maclennan of Rogart:
But those are not tools being used in the Netherlands, are they?
Mr Howarth: It is mainly the extended verification;
it is tighter verification of VAT numbers; it is making sure that
new companies when they register as traders are vetted properly
and consistency and continuously. It is not a case of: You have
a VAT number, off you go and start trading. It is a case of: "There
is your VAT number, you need to account for that, we will monitor
it and we will come back". So instead of coming back frequently
visiting the exporters, HMRC might consider it better to spend
their time visiting the rest of the trade, and particularly the
new traders, the new people coming on, to ensure they are trading
properly and legitimately, and these are the tools being used
by the other countries.
Q293 Lord Maclennan of Rogart:
Have these representations been made by you?
Mr Howarth: We have tried to open dialogue with
HMRC but they do not wish to sit down and talk about it. We put
various questions to them and we have written to them but we do
not get responsible answers, and when you find you are bashing
your head against a brick wall you tend to stand back and try
and find another avenue. We see the only way forward being to
legally challenge what they are doing.
Dr Cheetham: The problem is that the method
that Customs are using at the moment is allowing fraud to happen.
The fraudsters, the organised crime, the money is gone. I worked
closely with the Panorama programme which you may have
viewed, and the Belgian team who were on there say the losses
of 2005-06 were £8 billion, not the £3 billion that
Customs portrayed. The problem is that what Customs are trying
to do is trying to claw the money back from the other end of the
chain, from the legitimate companies at the other end, and the
money has already gone. The fraud has already occurred. There
are two ways of solving this problem. The first is to change the
legislation, the second is to try and sort it out in-house. If
you sort it out in-house you have to stop the fraud. All of Customs
policies have been to try and recover the losses from the legitimate
companies. The fraud takes place; they do not care. 100 successful
convictions for £8 billion lost is ridiculous. You have to
stop the fraud at the outset and not let it occur, which is why
the logging system I propose works so well for that . I have studied
these subjects for four years because I have been forced to with
my litigation with Customs & Excise. The problem is that the
fraud takes place and Customs try to recover the losses from legitimate
companies, and that cannot go on. Customs' latest weapon is to
close the affected trade sectors down and then they will stop
the losses, but you have already seen reports. They are shifting
into copper, water—the fraud is still going on.
Q294 Lord Cobbold:
As you have just said, this is an amazing costly problem to not
just this country but all European countries and measures seem
to be nibbling at the edges. Can you be a bit more specific? Do
you think there is a need for a complete rehash of the whole VAT
system?
Dr Cheetham: Let's look at changing the systems
first of all. No matter how this fraud is dressed up, it is very
simple fraud. Goods are brought in VAT-free from a Member State
to the UK, for example, VAT is charged and the VAT is not passed
across. Companies can collect hundreds of thousands, millions
of pounds of VAT in a very short period of time, and what you
have to do is look at that problem. What I have proposed in my
written evidence first is the simplest one, "base rating".
Rather than have goods passing between Member States zero-rated,
you choose the lowest rate of all the Member States, which is
about 15 per cent at the moment, and countries charge each other
15 per cent. Now in the UK that would limit the scope of the fraud
down to 2.5 per cent, the difference between 17.5 per cent and
15 per cent. So why have goods passing between Members States
at zero rating? Why not have it at base rating? And it would not
take much to change. All you would have to do is change the Sixth
Directive wording to remove "zero rating" and replace
it with the words "base rating".
Q295 Lord Cobbold:
But would not they not import from outside the Community altogether?
Dr Cheetham: No, because the VAT is paid direct
to Customs when it is brought from outside the EC Community. If
you bring goods in from America, as the goods hit the boundary
of Europe or the UK you must pay VAT direct to Customs or use
a deferment account, so Customs collect the VAT straight away.
So this fraud only works in Europe. So you stop the goods moving
at zero rate. You either use base rating or you pick a middle
rate and I call that median rating.
Q296 Lord Cobbold:
You cannot use the system applied in the United States?
Dr Cheetham: No. Fraud does not work between
the United States; only in Europe. Could you say that again, please?
Q297 Lord Cobbold:
Could you not apply the system applied in the United States to
imports from European countries?
Mr Howarth: That would restrict freedom of trade.
Under the Sixth Directive you are not allowed to restrict trade.
Dr Cheetham: Europe has to be a level playing
field—that is the whole idea of the Sixth Directive, to
create this level playing field. If you had this rate of 15 per
cent, or a middle rate—the range of VAT is 15-22 per cent
in the Member States so if you picked a middle rate of, say, 18
per cent and everybody selling goods between the Member States
just charges 18 per cent between the Member States, that will
eliminate the fraud. It is that simple. There will have to be
some balancing of the two-way trade between countries because
countries will be collecting VAT from other Member States, so
there will have to be some balancing depending on the outcome
of the trade levels. So the first option is base rating or median
rating. A second option obviously is to have a point of destination
tax. Now, point of origin tax was something that was considered
early on when this transitional system was implemented. What a
point of destination tax means is that you charge the VAT rate
of that country, so if Germany is going to sell to the UK they
will look up on the tables, the UK VAT is 17.5 per cent and they
will charge 17.5 per cent. To France, Germany will charge 16 per
cent. If you sit in the UK and you look outward now, you see that
if you are buying from the UK you are paying 17.5 per cent, and
if you are buying from France and Germany you are paying 17.5
per cent, and that creates the level playing field that the Sixth
Directive is meant to implement.
Q298 Lord Kerr of Kinlochard:
Could I, first, ask a technical question, and can I ask it of
Ms O'Hara first? I understand that every mobile telephone has
an identifying number, an IMEI number. Do Vodafone keep records
of all the IMEI numbers of all the telephones that pass through
their hands?
Ms O'Hara: Yes, I believe we do keep records.
Q299 Lord Kerr of Kinlochard:
Dr Cheetham, did your company, the one that was attacked in the
way you describe, keep IMEI records of all the telephones?
Dr Cheetham: My company was destroyed in 2002.
In that time we had bar code scanners for insurance purposes.
Since then it has become the norm, so in my day we only had the
records for insurance purposes.
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