20TH REPORT: STOPPING THE CAROUSEL: MISSING
TRADER FRAUD IN THE EU
Letter from Rt Hon Dawn Primarolo MP,
Paymaster General, HM Treasury to the Chairman
Please find enclosed the Government's response
to Sub-Committee A's report on Missing Trader Fraud. I hope the
Committee find the response helpful and informative.
I would also like to take the opportunity to
respond to the points you raised in your letter of 13 June 2007
to John Healey, Financial Secretary, following his recent letter
on Missing Trader Fraud.
You asked about the effect of the verification
strategy on honest traders. HMRC knows that most people and businesses
want to pay the right tax at the right time and are therefore
committed to making this as easy as possible. Customer focus is
a core HMRC value and HMRC constantly seeks to achieve the right
balance between customer requirements and compliance.
However, HMRC will deal firmly with anyone who
intentionally avoids their responsibilities. Government and HMRC
have a duty to protect the revenue. The response to VAT Missing
Trader Fraud has been, in my view, proportionate, targeted and
risk-based. The courts, to date have supported HMRC's policy and
practice.
The strategy for tackling MTIC fraud is risk-and-intelligence
based and HMRC's interventions to verify repayment claims are
targeted at specific activity indicative of trading in supply
chains tainted by VAT fraud. There was a dramatic escalation of
activity by companies trading in goods traditionally associated
with MTIC in the first part of 2006 for which HMRC was unable
to identify any legitimate commercial reason. This was accompanied
with dramatic increases in the value of VAT being reclaimed by
these companies. HMRC and I consider it proportionate, given the
huge sums of public money involved, that those involved in such
a large and unexplained growth in trading should have their large
repayment claims investigated before payment.
Given the contrived and highly-orchestrated
nature of the supply chains, it is inconceivable that any business
can be unaware of MTIC fraud, or not suspicious of the trading
patterns and practices encountered. Although the repayment claims
have been pre-selected on risk criteria, verifications are not
commenced with any pre-determined outcome in mind, and the aim
from the beginning is to establish the facts and the true nature
of the relevant transactions as soon as possible. It is only when
this has been established that HMRC can then determine the validity
of the claim. Of 95% of the traders whose repayments have been
selected for verification, HMRC have to date found firm evidence
of fraud in 34% of cases by value. Of the remaining 66% they have
identified strong indicators of links to MTIC fraud, requiring
them to undertake further investigation to determine the veracity
of these claims.
If at any time it becomes clear that the transactions
HMRC are verifying do not form part of an overall scheme to defraud—for
example, when a claimant has purchased goods direct from a manufacturer
for wholesale distribution to the retail market—then arrangements
are made to release any monies withheld. Similarly, HMRC pay input
tax claimed in respect of legitimate business overheads such as
accountancy costs or freight forwarder charges,once satisfied
of their veracity.
The introduction of the reverse charge on 1
June 2007 will remove immediately the threat of fraud in the goods
to which it applies, enabling honest genuine traders in those
goods to continue trading free of the risks of MTIC fraud in their
industry.
FINANCIAL GUARANTEES
You also commented on the provision of financial
securities to businesses facing hardship. I note the point you
make here, but to date HMRC have found that questions and comments
about financial security from traders under verification have
not focused on the fact that they are unable to convince banks
about the long-term viability of their businesses.
FRAUD LEVELS
As you have stated, our practice is to publish
fraud estimates alongside the PBR and we are unable to provide
an interim figure. However, HMRC has updated the trade statistical
data that was previously provided to the Committee and the table
is below.
Estimates of missing trade associated
with MTIC fraud in the UK
| Quarter ending
| Value of MTIC- related trade (£bn)
|
| September 2004 | 0.6
|
| December 2004 | 0.7 |
| March 2005 | 1.0 |
| June 2005 | 2.3 |
| September 2005 | 3.5 |
| December 2005 | 4.4 |
| March 2006 | 11.8 |
| June 2006 | 14.7 |
| September 2006 | 2.1 |
| December 2006 | 0.4 |
| March 2006 | 0.3 |
25 June 2007
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GOVERNMENT RESPONSE
77. We recommend that Government works with other Member
States to ensure that the Court of Auditors' proposed changes
to the Community Transit system are prioritised in order to attack
the supply chain for this variant of MTIC Fraud.
The Government is working with other Member States to
secure improvements to the Community Transit System (CT) as a
matter of priority. In particular, HMRC is actively working with
the Commission and other Member States to support improvements
both in the use of New Computerised Transit System and in the
development of improved control procedures, which are intended
readily to identify goods subject to MTIC Fraud being moved in
the CT system.
78. Missing trader intra-community fraud is occurring
on a substantial scale across the European Union. We agree with
HMRC that this is an outright attack on the tax system, and note
that it precipitates other crimes, such as theft of consignments.
We accept the evidence that the majority of the fraud is being
undertaken by a small number of criminal gangs.
The Government welcomes the Committee's conclusion.
79. As things stand, HMRC has no option but to continue
with extended verification; however they need to take real and
substantive steps to ensure that their actions do not damage the
innocent and are proportionate to the scale of the fraud. We note
that, according to the Paymaster General, this approach has led
to a "massive drop" in attempted MTIC fraud in 2006-07.
This appears to justify their approach; however, the system of
extended verification is an inefficient and unsustainable use
of HMRC's resources, and does impose a significant burden on smaller
firms.
The Government welcomes the fact that the Committee
recognises that HMRC's extended verification exercise was justified
by the very large reduction in attempted fraud. It considers that,
given the unusual circumstances surrounding what was an unprecedented
attack on the VAT system, HMRC's response proved to be an efficient
and well-targeted use of resources.
In the longer term, HMRC expects that their multi-faceted
approach, supported by the introduction of the reverse charge
and the extension of joint and several liability, will enable
them to reallocate resources from the verification exercise to
other compliance-related work.
Most businesses want to pay the right tax at the right
time and HMRC are committed to making this as easy as possible.
Customer focus is a core HMRC value and HMRC constantly seeks
to achieve the right balance between customer requirements and
compliance.
Extended verification is tightly targeted on claims
from businesses whose trade HMRC suspects to be connected to MTIC
fraud. Only 1% by value of the VAT withheld under this programme
has been found to be correctly claimed and properly payable. In
over 95% of cases where traders have been subject to extended
verification, HMRC has found either evidence that they have been
participating in or profiting from trading linked to MTIC fraud
(and therefore their repayment claim is not properly due), or
sufficient grounds to justify further investigation to determine
the veracity of the claims. In any case, where HMRC are satisfied
that any part of the claim is valid, for instance where it relates
to legitimate business overheads such as accountancy costs, they
repay the appropriate amount.
It is inevitable however that it can take HMRC officers
much longer to verify the ever more complex supply chains that
may be tainted by fraud and reach a decision on whether repayments
are properly due. As soon as they have satisfied themselves that
even part of the claim is valid, they repay that part immediately.
The courts, to date, have fully supported HMRC's policy and practice.
80. lt is generally accepted that the broad phenomenon
of MTIC fraud is out of control; we expect it to continue to mutate
into other sectors.
Indicators show that levels of fraudulent activity have
fallen dramatically since the inception of HMRC's verification
activity. The Government does not, however, underestimate the
possibility that the fraud could mutate into other sectors. Although
there is no evidence to date of widespread mutation into other
goods, HMRC have put in place resources and an intelligence framework
to identify and tackle risk areas if they emerge. In addition,
the Government has recently extended the scope of the joint and
several liability legislation to help counter any mutation into
electronic goods used for leisure or recreation, the next most
common category of goods used to perpetrate the fraud.
81. We suggest that HMRC should undertake further work
to examine the viability of real-time data capture of transactions
by VAT-registered companies.
The European Commission is undertaking work to evaluate
such a proposal and the UK is actively participating in this work.
The Government will support such change to the VAT system if it
is clear that the additional burdens on business are justified
as a proportionate response to tackling the fraud and potential
fraud.
82. HMRC's current strategy has succeeded in containing
MTIC fraud, but will not eliminate it; the Government sought the
reverse charge derogation because HMRC's current strategy is unsustainable.
The reverse charge will stop MTIC fraud where it has been most
prevalent, but we expect the fraud to migrate and mutate. Consequently
we anticipate that when the UK's derogation is reviewed in two
years time there will be requests for the reverse charge scheme
to be expanded, either to other Member States or other products,
or both.
The Government welcomes the Committee's recognition
that the reverse charge will stop MTIC fraud in the areas where
it has been most prevalent. The reverse charge only came into
effect on 1 June, and accordingly the Government feels it is premature
to consider whether it will seek renewal of the reverse charge
and if so what its scope should be.
83. The current mechanism for intra-community VAT transactions
is not sustainable. While the amount of money being lost in the
UK may have fallen in 2006-07, mutation into other industry sectors
will bring a subsequent rise in fraud levels. We believe that
prevention is better than cure. A wide-ranging change to the VAT
system is required and the Government should start discussions
with the European Commission and other Member States on the form
this should take.
The Government believes that the current mechanism for
intra-community VAT works very well for the vast majority of business
transactions throughout the EU. MTIC fraud is a sustained and
organised criminal attack on the system that exploits a weakness
in the VAT treatment of cross border trade in order to commit
fraud. The Government is actively engaged with our European partners
in looking at a wide range of measures, including the use of a
wide reverse charge, the taxation of intra-community trade, and
a number of other options to improve the working of the current
system.
As the report recognises, the Government firmly believes
that any change to the VAT system must fit three criteria:
— the right tax ends up in the right place;
— the potential for fraud and non-compliance is
minimised; and
— business is not overly burdened.
It is with these criteria in mind that we are engaged
in these discussions.
84. We believe that an Origin System or Flat Rate origin
system without a clearing house merits further serious study.
The Government believes it is extremely difficult to
envisage agreement to any origin system, whether applying the
rate VAT of the Member State of departure, or a flat rate, without
a clearing house. The system would involve a net revenue loss
for those Member States who import more goods from other Member
States than they export, and a corresponding gain by those with
surpluses. It would therefore effectively represent a levy on
their EU trade deficit in goods.
Reflecting this, the report correctly points out that
there would be winners and losers to this system. Indeed, footnote
42 on page 29 shows that the UK would effectively lose some €8.6
billion of VAT revenue, based on 2006 trade figures. And it would
not just affect the UK, as some 16 other Member States would be
losers to some degree. In contrast, a few winners would massively
benefit, some by as much as €15 billion. It is very unlikely
that Member States would unanimously agree such an unfair system
and one which, certainly for the UK at least, simply replaces
one loss of revenue, which is being combated, with an even greater
one.
However, the Government remains committed to exploring
EU solutions and is engaged in discussions with other MS's on
a range of options.
85. Harmonisation of the VAT rates would remove the opportunity
for MTIC fraud. The UK is not alone in opposing this harmonisation.
Doing nothing is not an option. A continued ratcheting up of the
complexity and compliance requirements related to the existing
system will impose increasing costs on legitimate business. A
solution to MTIC fraud will benefit every Member State: countries
need to recognise this and agree to act together. It is now time
for the Government and other Member States to look more sympathetically
at a radical change to the VAT system. The flat rate origin system
proposal, with or without a clearing house, merits further serious
study of the potential impact on business, levels of trade, and
Member State revenues.
Harmonisation of VAT rates would not of itself remove
the opportunity for MTIC fraud. It is not this lack of harmonisation
that allows the opportunity for the fraudsters to steal the VAT,
but the mechanism for cross border trade. The report is quite
right that the UK is not alone in opposing harmonisation, and
this is because the vast majority of Member States recognise the
right of a Member State to set the rate of VAT appropriate to
its own social and economic needs.
Following discussion at ECOFIN on 6 June, the UK will
be examining, with its European partners, a range of possible
changes to the VAT system, including the use of the so called
flat rate origin system, but only when accompanied by a clearing
house system. The European Commission is exploring this possibility
further and will be presenting their findings to the Council by
the end of 2007.
86. We invite the Government, when responding to this
report, to assess the relative merits of all the options for reform,
which it describes.
The options for reform presented by the report would
deal with MTIC fraud in its current form, but each would be in
danger of failing at least one of our three core criteria, that
of the right tax ending up in the right place; that the potential
for fraud and non-compliance is minimised; and that business is
not overly burdened.
A generalised reverse charge would lead to an increased
burden on businesses/administrations and increased fraud opportunities
at the retail end. The taxation of intra-community trade in the
Member State of destination would also lead to increased fraud
opportunities, due to businesses reclaiming input VAT on cross
border invoices and the difficulties administrations would face
in recovering VAT from non established businesses. The taxation
of intra-community trade in the Member State of origin, creates
new, large revenue risks and for reasons already explained, necessitates
a clearing house system in order to satisfy the first criterion.
However, the UK and our European partners are looking
at these radical approaches, and indeed the Commission is carrying
out a study, due to report to the Council by the end of this year,
on both the generalised reverse charge and the flat rate taxation
of cross border trade with a clearing house system. As part of
this process we will explore ways of mitigating the risks. It
is when this activity is complete that we will be in a position
properly to assess the merits of the options for reform.
In addition, the UK is participating in discussions
on changes to the current EU VAT system, such as improving the
frequency and efficiency of the exchanging of information between
Member States, and strengthening the joint and several liability
legislation. These are changes which can be implemented in the
short term and may prove effective long before any radical changes
could be approved.
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