Examination of Witnesses (Questions 320
- 339)
TUESDAY 17 APRIL 2007
MR MIKE
ELAND, MR
TONY WALKER
AND MR
RICHARD BROWN
Q320 Lord Maclennan of Rogart:
I wonder if you could explain why it is thought that the position
requires the United Kingdom to have a derogation and why other
countries would be perceiving this as a British problem. Is this
simply not going to transfer the problem to other countries potentially?
Mr Eland: We do not think it is something that
will automatically transfer the problem to other countries. A
number of other countries have expressed interest in fact in having
a similar reverse charge. We have had a particular problem in
this sector, we feel this is a proportionate and sensible response
to it and we have convinced other Member States that it is right
and proper that we should go ahead and do it. If I look back to
similar problems we had in the gold bullion industry, I think
it was in the 1980s, a reverse charge was introduced there which
I think now is a standard part of the VAT rules of the European
Union, so it is always possible if this is seen to work effectively
in the UK, as we hope it will, that other countries will look
to follow suit or indeed that the Commission might decide to take
it up as a proposal, so I do not think we are exporting the problem.
Chairman: In any case, we will want to
ask further about this when Lord Kerr asks about the general question
of migration.
Q321 Lord Cobbold:
All of us have had letters from British companies that have suffered
from delay in VAT repayments lasting up to a year, which in one
case bankrupted the company. Why does verification take so long?
Why should it last for a year or more, that whole process?
Mr Eland: The verification activity is essentially
looking to see whether the companies involved in fraud ignored
signs that they were becoming involved in fraud. That is quite
a stiff test to establish. It is also an extremely complex area
of activity where the fraud is structured in such a way as to
deliberately try and conceal further fraud from our activity.
In one of these investigations, over 600 companies have been involved
in a set of complex, interrelated transactions, so it is a major
piece of investigative work that has to be undertaken. What we
do do, because obviously we are concerned to ensure that we do
not damage the innocent, is we review periodically at various
stages in the process whether we have sufficient evidence and
reason for suspicion to continue with the investigation, and we
believe we have in all the cases that we still have under the
process.
Q322 Lord Cobbold:
Do you think you have caused bankruptcy for innocent traders?
Mr Eland: We have put in place a process so
that people who say they are facing hardship in terms of not getting
repayments back can come and talk to us about that. We are prepared
to make repayments if security or a bank guarantee is offered
and we also make repayments of any parts of the transaction that
we feel are clearly not linked to any fraud, so business overheads
and things like that we have repaid and on any non-associated
transactions. Throughout we have tried to maintain the right balance,
but we do have to protect the public revenue against what was
a major attack on the system in the early part of last year.
Q323 Lord Cobbold:
This particular businessman says he approached Revenue and Customs
and never had a response from them.
Mr Eland: Well, I cannot, I think, comment on
an individual case, but we have publicised this. We write regularly
to all the traders who are involved in this campaign, telling
them how the investigation is progressing and we have made it
clear to people, that we have a central contact point that has
been made available. If anybody is dissatisfied with the way we
handle these cases, they have not only access to judicial remedies,
they also have access to our independent adjudicator and they
can complain to their Member of Parliament and so on. We do try
to give people avenues if they are dissatisfied with the way we
have handled any individual case.
Q324 Lord Cobbold:
Do you think there is scope for improving the flow of information
by electronic means, as I think there is in the building trade
already and we are all familiar with credit card possibilities?
Is there any way to make the process more acceptable to business?
Mr Eland: Yes, and I know this is a specific
question that you asked in relation to the construction industry
scheme. We have set up a facility that enables people to ring
and make enquiries about VAT-registered businesses, so there is
a sort of mainstream service which anybody can ring up, any registered
trader can ring up and check a registration number. For those
who are operating in these high-risk sectors, we have, in addition
to that general service, added a special service where they can
go a bit further than just checking whether the VAT registration
number is relevant and also go on to look at whether or not there
are details that they have been given about the individual and
whether they match with details we have been given. We are looking
to introduce electronic checking into the registration process
so that we can carry out the registration checks in a faster way
and cut down on the time it takes for people to get a registration
number, so where we can, yes, we do want to provide a service
and use electronic means to develop it and deliver it more effectively.
Q325 Lord Maclennan of Rogart:
I was going to raise a question about the legislation on joint
and several liability prior to the Chancellor's announcement that
the HMRC had the power to make one trader jointly and severally
liable for another's fraudulent tax, and what I wanted to ask
was whether you could give us some indication of the impact of
that legislation as it has operated both in respect of the number
of cases and the value of the claims that have been withheld,
and then perhaps you could go on to indicate the reasons for the
announcement in the Budget of the changes to take place on 1 May
to extend the operation of the law.
Mr Eland: Yes, in terms of the joint and several
liability legislation as it operates now, we have predominantly
found it useful as a deterrent and as a means of offering a warning.
We have issued around, I think it is, 1,000 warning letters to
people where we feel there is an increased risk and that they
are in danger of being made jointly and severally liable, and
that has actually, we feel, mostly been sufficient. We have actually
had to go on beyond that and impose the joint and several liability
in relatively few cases.
Q326 Lord Maclennan of Rogart:
Can you say how that warning works and what you think the consequences
of it are?
Mr Walker: When certain facts have been established,
it is a letter that we would write to the VAT-registered business,
indicating that there had been tax losses in the transaction chain
and effectively warning them to take more care in future and,
should they not take sufficient care, they may be jointly and
severally liable on the tax due on future transactions.
Q327 Lord Maclennan of Rogart:
This is related to the particular trader who receives the warning
letter that there has been some evidence of misfeasance?
Mr Walker: In the transaction chain.
Q328 Lord Maclennan of Rogart:
In that particular transaction chain?
Mr Walker: Yes.
Q329 Lord Maclennan of Rogart:
But not such as to warrant intervention legally?
Mr Walker: Well, the intervention is to give
a warning on that occasion that if that sort of activity continued,
then that is when we would consider applying the joint and several
liability legislation.
Q330 Lord Maclennan of Rogart:
But it is either illegal or not, what has been going on before.
Are you saying it might be illegal, you do not know, or what are
you saying?
Mr Walker: It is part of the administrative
procedure to implement the joint and several liability legislation.
As part of that process, we undertook to provide a warning in
the first place, so, strictly speaking as far as the law is concerned,
we could have applied it on that occasion, but, as a matter of
administrative practice, we undertook to Parliament actually to
offer up the warning letter in the first instance, so the legal
position is that the business would still, strictly speaking,
be jointly and severally liable, but we are offering that warning
in the first instance.
Mr Eland: That does not stop us obviously from
pursuing people in other parts of the chain, some of whom we might
have other evidence against and can take action there.
Q331 Lord Maclennan of Rogart:
So you have not actually withheld claims under this, it is in
terrorem?
Mr Eland: We have gone on in a small number
of cases to further stages, but we have found that the impact
of this warning letter has been sufficient in the vast majority
of cases.
Q332 Lord Maclennan of Rogart:
To do what?
Mr Eland: To stop them trading in dubious transaction
chains.
Q333 Lord Maclennan of Rogart:
So you have really just choked off the business at that point
with that warning letter?
Mr Eland: Well, we have choked off the illegitimate
business, yes.
Q334 Lord Kerr of Kinlochard:
My question follows exactly on from what Mr Eland has just been
saying in answer to Lord Maclennan. I am struck as this inquiry
has gone on by the evidence that you have been very successful
in stopping the fraud in computer chips and mobile phones. But
the evidence also suggests that you have done that by closing
down large sections of the trade, and that "extended verification"
means that the papers rest with you for quite a long time, while
no payments are made. You mentioned access to judicial remedies,
but we have seen some evidence that the authorities have been
opposing hearings in cases brought by some of those affected,
and you might want to comment on that. But it seems to me that
our congratulations to you on achieving the reverse charge derogation,
which presumably solves the problem in relation to these two commodities,
have to be tempered by our growing feeling that this success will
be followed by the migration of the problem to other sectors.
In her letter of 27 March, the Paymaster General suggests possible
migration to textiles, razor blades, golfing equipment, pharmaceuticals,
soft drinks as well as the hot favourites, iPods and SatNav systems.
I guess that you must be considering how to prepare to deal with
migration, just as no doubt there are people out there preparing
to migrate. What are you going to do? Is it to be the same sledgehammer
technique of so-called "extended verification", which
seems to mean that for up to, or over, a year you freeze the accounts,
not just of companies against which there is prima facie evidence
of fraud, but quite widely, and so cause problems for a range
of firms? Also, if the variety of fields to which the fraud might
migrate are as wide as the Paymaster General in her letter of
27 March suggests, will it not affect a lot of sectors of the
economy if you resort to the same method, if that is indeed what
you are going to do, in areas where you expect to see problems
as a consequence of your success? I am sorry, if this amounts
to rather muted congratulations: I do congratulate you on achieving
the derogation.
Mr Eland: I would like to address the issue
of migration, but I would also like to come back either in answer
to this question or later to talk about the verification campaign
because I do not think actually it is as some of your witnesses
have characterised it and as you have there. If I could deal with
the migration issue first, I think we feel that the fraud got
established in the computer chip and telephone sectors at a time
when both sectors were subject to huge growth because of commercial
reasons and also when we were very unsighted of the forms in which
the fraud took. We think that if the reverse charge stamps out
that fraud in those sectors, it is actually quite difficult for
fraudsters to move into other sectors on the scale in which they
have been able to establish themselves in those two sectors without
it becoming apparent to us through various monitoring activities
that we will put in place at an early stage. You cannot eliminate
fraud totally from any system, but I think we feel that, through
intelligence sources, through monitoring systems that we can now
do using electronic matching and so on, we can detect movements
into other areas at a much earlier stage and take prompt and quick
action at that point so that it is not growing into the scale
that it did become in the chips and phone sectors, so that is
some of the activity that we are going to do there. Obviously
we have a huge amount of data that is supplied to us through VAT
returns and the like. Modern technology, search engines and those
sorts of things enable a lot of cross-checking of different information
streams which help to detect patterns of unusual trading at a
much earlier stage and that will be our first line of defence
there. I do not want to be complacent about our ability to track
that. We are dealing with extremely resourceful people here and,
therefore, I will not rule out that we might also see an extension
of the reverse charge. Equally, the joint and several liability
legislation, the reason why we are extending that in the Finance
Bill, and I am sorry, Lord Maclennan, I did not answer that part
of your question, is because we are looking ahead and saying,
"Well, might there be a move into some of these fringe activities,
like iPods and so on? If so, let's have that joint and several
liability legislation in place so that we can use that".
We are also introducing in that Bill the power to vary some of
the joint and several liability legislation by order, so again
we have got another weapon to enable us to be able to do things
if this fraud starts to emerge in other areas, so we will need
to be very vigilant. We might need new legislative means and so
on to tackle it, but I feel that we are in a different situation
with a move into new sectors than we were in, seeing it become
very well established before we were really on to it in these
two earlier sectors.
Q335 Lord Kerr of Kinlochard:
I was going to ask why, but in the light of your answer I would
say when, but if you begin to suspect that it is migrating into
another sector, will you, in addition to the things you have described,
be applying the "extended verification" technique which
you have been using up to now?
Mr Eland: That might well be part of it, yes.
Would you like me to go on to explain the extent of the verification
process and the risk process?
Q336 Lord Kerr of Kinlochard:
To us, it looks a bit like a blunt instrument.
Mr Eland: Well, I do not accept that it is,
and I think that it is important that I do explain that to the
Committee and if I may I will do so in response to this question.
Perhaps I could just give a little background. To make this fraud
operate, you need three groups of people. You need the organisers,
a relatively small number of people, and we will be coming on
to who they are and so on later. You need the missing traders
who are usually men of straw and the whole purpose of them is
to have no assets, and then you have got a whole raft of people
in the middle without whom this fraud cannot work. They have to
have a degree of knowledge of what is happening, otherwise you
cannot keep a carousel moving. To make a carousel move, people
have to sell to the right people and they have to sell at the
right price, so it is not just a set of haphazard transactions
which somehow seem to manage to keep going round in the same circle,
but it clearly needs an element of contrivance there, so it is
that middle group of people that we are looking at in the verification
process. Those groups are not the whole industry. We think that
the reverse charge will affect something like 15,000 companies.
The number of people whose repayments we are investigating in
this verification campaign, and I do not want to get into the
precise details, but it is a very small part of that 15,000 and
in percentage terms it is in single figures, so it is not the
entire industry, as some of the people giving evidence before
you have, I think, suggested.[1]
How have we selected those people? Well, we have done so by looking
at things like patterns of trading, but we have also done so in
relation to particular flows of trade. I did ask the Clerk to
make sure you all had copies of the letter of 27 February from
the Paymaster General and annex A to that letter which shows a
table which gives figures produced by the Office of National Statistics
of the value of trade in these sectors over a time period. If
you look at those, you will see that in 2004, a typical quarter
was something like £0.6 billion in trade and that then gradually
grows through December 2005 and in the first two quarters of 2006
that jumps to £11 billion and £14 billion. Now, there
is, I think, no way that we feel that that trade is any sudden
new grey market which has appeared. We have talked to members
of the big four accountancy firms, we have talked to mobile phone
manufacturers and so on, and we have found no commercial explanation
for that dramatic jump, nearly tenfold, and it is that period
of repayment claims made in relation to that volume of trading
with this select number of people that we are investigating. We
are not doing so in order to delay the repayment; we are investigating
whether it should be made at all. Where we feel we have evidence
and that the company involved either knew or should have known
because of the way in which they were asked to construct their
commercial supplies, then we feel under the legislation that we
are entitled, indeed obliged, to refuse that repayment. Therefore,
I would characterise this not as a sledgehammer, but as a targeted
investigation of attempted fraud on the system. Now, I am not
accusing everybody in that chain of being a fully complicit party
to the fraud, there is a variety of different degrees of evidence
here, but what we are doing is looking very carefully at all of
the transactions, at the relative prices and so on that they give
to test whether or not those are genuine commercial transactions
or actually cover for this fraud. That is the purpose of it and
I do not think we are being disproportionate and I do not think
it is a sledgehammer.
Q337 Lord Kerr of Kinlochard:
Thank you very much, that was an extremely helpful answer and
it clarifies a lot of things. The doubt that is left in my mind
is that, whilst we would all wish you to succeed in stamping out
fraud, and nobody is suggesting that it is not right to act firmly
against fraud, you may be asking traders to prove a negative,
to prove that they did not know or that they could not have been
expected to know that somebody else in the circle was a fraudster.
That is inherently difficult to do. I am now talking of the legitimate
trader caught up because one of your traffic lights has gone to
amber, he needs to prove a negative to get his money and you are
not required to prove a positive, and you sit on his payment.
Is that unfair?
Mr Eland: No, I think we are required to prove
either that they did know about the fraud or that they should
have known. We have not any case law, I think, on `should have
known'.
Mr Walker: Not specific cases, no.
Mr Eland: But I think it is more than the negative.
As I say, I think what a lot of our questioning is around is whether
or not these are genuine commercial transactions and it is very
rare, I think, in commercial trading practice where you get a
pattern where the margins are exactly the same, no matter whether
the volume fluctuates, where suddenly people appear out of nowhere
and are able to supply millions of pounds worth of mobile phones.
We are asking those questions, "What action did you take?",
"Why did you enter into these transactions?", so I do
not think we are asking them to prove a negative.
Q338 Lord Blackwell:
While we are on this table you have provided us with, Mr Eland,
you said that your intelligence will enable you to see where migration
is taking place and that that will help prevent this, but it is
clear from this table that you were aware of counts of fraud on
phones and chips back in 2005 and yet there was that huge peak
in the middle of 2006. It is not clear to me, the fact that you
know in general terms that people may be switching into iPods
or cameras or whatever it is without applying the same verification
process, what it is you would do that would prevent it.
Mr Eland: Can I just comment on why we think
there was that surge in that quarter which is that in January
of that year there was the Bond House judgment which ruled
that our previous strategy, which was keeping the fraud down,
was not valid in law and, therefore, there was this explosion
of activity immediately following that. Fortunately, that case
did also provide this new approach, that the repayment could be
denied if we could prove this `knew or should have known' test
and, therefore, we have put in place immediately we saw those
surges, this detailed investigation of repayment claims relating
to those periods.
Q339 Lord Blackwell:
So, in practice, if you now knew that the new thing was going
to be product X, you would direct your army of people looking
at this to scrutinise transactions going on in that, or how would
it work?
Mr Eland: No, if you are an established supplier
of razor blades or something, if this is the worry of the Committee,
we are not suddenly going to say, "Oh, we think that there
is a slight surge in trading in that area and, therefore, we are
going to investigate every single trader there", and I think
that was your worry, Lord Kerr. We would not respond in that way.
We would be looking more at the new activity that had emerged
there, concentrating our investigation efforts on that.
Lord Kerr of Kinlochard:
So we can carry on shaving!
1 Note by witnesses: I would like to expand
on what we mean by the 15,000 companies. HMRC's administrative
VAT data shows that there are around 15,000 VAT registrations
within trade sectors most likely to be affected by reverse charge
eg mobile phones, computer chips etc. This does not mean that
all of these 15,000 companies will have to change their accounting
procedures on introduction of the reverse charge; in fact, the
great majority will not have to do so as their sales will come
below the threshold of £5,000 or relate to mobile phones
supplied with an airtime contract. Back
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