House of Lords - The Fight Against Fraud on the EU's Finances

The Fight Against Fraud on the EU's Finances - European Union Committee Contents

CHAPTER 4: the EU dimension ii-the proposed fraud directive

42. In this chapter we consider the recently proposed Directive designed to protect the EU's financial interests by the criminal law, which in part is designed to address some of the deficiencies in the Member States identified in the previous two chapters. In addition, in light of the evidence, we look at the high levels of VAT fraud perpetrated within the EU. This focus on VAT will also enable us to discuss one of the Government's key concerns with the Directive, namely its scope.

The Directive on the protection of the financial interests of the EU by the criminal law

43. This draft Directive was foreseen in the Commission's Communication of May 2011.[77] It would, if adopted, require the Member States to pass legislation on fraud-related offences. The proposal is based on common definitions, including definitions of "fraud",[78] and the "EU's financial interest",[79] and it also includes a uniform range of penalties.[80] The Directive would replace an EU Convention on the Protection of EC Financial Interests of 1995.

44. The Commissioner emphasised the importance of the Directive to the anti-fraud fight and told us that he proposed it because it will "enable national prosecution services to operate more effectively cross-border and will create greater deterrents against fraud throughout the Union".[81]

45. In December, the European Court of Auditors (ECA) issued an Opinion addressing the Commission's proposal.[82] The ECA welcomed the principle that "an equivalent and effective protection of the European Union's financial interests should be established throughout the Member States in order to prevent the loss of EU money and thus ensure legitimate implementation of the budget".[83] The ECA argued that a clear definition of the concept of the Union's financial interest "is central to all legislation relating to the fight against fraud" and suggested that the proposed definition should be clarified.[84]

46. In correspondence with the Government, this Committee has welcomed this proposal. Many of the MEPs also welcomed the Directive. Both Dr Theodoros Skylakakis MEP and Timothy Kirkhope MEP described it as "important",[85] with Mr Kirkhope welcoming the proposal as it would send out "the clear and simple message that fraud will not be tolerated in the EU".[86] Dr Ingeborg Grle MEP described the proposal as "remarkable" because the draft includes an attempt "to achieve a common definition of what constitutes fraud", but she added that "we could have done a lot more and we should be doing more".[87] She also lamented the fact that there is "no general approach to try to tackle fraud and organised crime in general" (emphasis added) because this would, in her view, "have caused uproar in the Member States".[88]

The Government's view of the Directive

47. Aside from the concerns expressed in their Explanatory Memorandum, it is clear that the Government do not share the MEPs' enthusiasm.[89] Whilst welcoming attempts to protect the EU's funds, the Exchequer Secretary said that the Government were nervous about this proposal because they fear that it "has the capacity to expand the EU's competence in the sphere of tax".[90] In particular, he voiced the Government's concern that the proposed Directive could encroach on the Member States' responsibilities to control and operate the VAT system which in his view must remain the responsibility of the individual Member States. The Exchequer Secretary argued that the draft "has the potential to expand the EU's role and competence into this type of fraud work" and that the UK was not alone in having this concern. He concluded that "[I]t has been the long-standing position of this country that we want to defend our sovereignty in this area" and he did not think that this problem would be easily overcome.[91]

Value Added Tax

48. We saw in Chapter 2 that the Commission found that agriculture and cohesion policy were the two main areas in 2011 which suffered the highest levels of fraud,[92] but our evidence also raised the issue of VAT fraud.[93]

49. VAT was first introduced in Europe in 1954, in France. In 1967 the then six Member States of the European Economic Community agreed to introduce a common VAT system. The system is now governed by a Directive which introduces common rules on the application of VAT but also allows the Member States some leeway on its application.[94] In 2010 the Commission calculated that the total VAT receipts collected by the 27 Member States in 2008 was €862 billion. Today, on the basis of a complicated system described by the ECA as "complex to the point of incomprehensibility"[95] a percentage of the VAT base[96] is used to calculate the individual Member States' VAT based contributions to the EU.[97] The Government told us that in 2011 the UK's VAT based contribution to the EU was £2.2 billion.[98]

50. Based on a study it commissioned, the Commission estimated that in 2006 the VAT gap, that is the difference between actual VAT receipts and what the Member States should theoretically receive based on the size of their economies, was 12 per cent; a figure just over €100 billion equivalent to two thirds of the entire EU budget for 2011.[99] The VAT gap is not entirely the result of VAT fraud[100] but, as the Court of Justice has recognised in its case law, the subsequent diminution in the level of the Member States' VAT receipts caused by VAT fraud will inevitably have an impact on the amount each Member State contributes to the EU with a commensurate impact on the overall size of the EU's budget.[101]

51. The main source of VAT fraud in the EU is carousel fraud, which is also referred to as Missing Trader Intra-Community (MTIC) fraud (see Box 4).

BOX 4

MTIC/Carousel fraud in the EU

Carousel fraud or MTIC fraud is a fraud perpetrated against the VAT system involving a series of often non-existent transactions involving the purported movement of goods and services within the Single Market, in and out of the Member States, in order to obtain a VAT repayment from the local revenue at the point the goods leave the Member State. The process was described by David Gauke MP as "[E]ssentially … a circle of transactions whereby one participant claims for recovery of the VAT that they have apparently incurred, but no VAT is ultimately paid to the Exchequer".[102]

The Director of Europol, Rob Wainwright, gave a flavour of the range of methods used by criminals engaged in MTIC fraud: "from the carousel trading of mobile phones, computer chips and precious metals to fraudulent trading in intangible items, such as carbon credits, gas and electricity and green energy certificates".[103] Michle Coninsx, the President of Eurojust, cited the significant work undertaken by her organisation in assisting the Member States in recovering funds fraudulently obtained from the VAT system.[104]

In the UK, the Exchequer Secretary estimated that at its peak in 2006 £3-£4 billion was lost to MTIC fraud; but he suggested that the most up-to-date figure was now £0.5-£1 billion a year.[105]

Is MTIC fraud, fraud against the EU's budget?

52. In light of the fact that the Member States receive 97 per cent of VAT revenue even Commissioner Šemeta as anti-fraud Commissioner recognised that "it is the Member States who should be strongly interested in addressing [the] problem of VAT fraud", but he also told us that it was his intention to include VAT/MTIC fraud within the scope of the proposed Directive.[106] He recognised that "some Member States do not agree"[107] but stated that the legislation has been drafted with the Court of Justice's jurisprudence on this matter in mind.[108] He added that "VAT should be subject to this Directive because it is part of EU-own resources—it is part of the revenue of the EU budget".[109]

53. Europol told us that some Member States have refused to work with OLAF on VAT fraud on the grounds that the Commission and OLAF do not have competence in this area.[110] The Exchequer Secretary was also clear that the Government do not see MTIC/VAT fraud as fraud against the EU's budget;[111] especially given the fact that 97 per cent of the money raised goes to the Exchequer.[112]

54. We asked the Government whether it is necessary to have a European dimension to tackle MTIC fraud because those who perpetrate it are taking advantage of the open system of trading within the Single Market. The Exchequer Secretary agreed and said that "there is scope for cooperation between tax authorities"[113] and his officials[114] offered the example of Eurofisc.[115] But, when asked whether the percentage of the figure which as a consequence of MTIC fraud in the UK which does not then go to the EU, constitutes fraud against the EU's budget, the Exchequer Secretary argued that "there is a danger that we view VAT fraud as being predominantly or significantly an EU matter when the responsibility to address this, and the consequences of VAT fraud, are felt overwhelmingly by Member States".[116]

55. At the outset of this inquiry, as we have already noted, the Government were of the view that VAT fraud was outside the scope of our investigations. However, we consider that we were justified in pursuing the matter since the Exchequer Secretary told us that although the majority of VAT raised stays in the UK Treasury the very small proportion due to the EU amounts to £2 billion which is a large enough sum to be of concern both to the UK Government and the EU.

56. We have heard evidence of very significant levels of VAT fraud. The Committee understands the Government's opposition to any measure or action which would extend the EU's competence into tax enforcement in the UK. But this legitimate concern should not allow fraud which diminishes the amount due to the EU to be ignored or not pursued with vigour. It is beholden on the UK Government to come forward with alternative robust proposals that will address these matters.

57. We remain of the view that the proposed fraud Directive has merit; in particular, its attempt to bring uniformity to the EU's classification of these offences. We expect that it would have a positive impact on the Commission's ability to acquire a more accurate statistical analysis not only of VAT fraud but also levels of fraud in general in the EU. In turn this will assist everyone in their efforts to protect the EU's financial interest.

77 The Justice, Institutions and Consumer Protection Sub-Committee currently retains the Directive under scrutiny and is engaged in separate correspondence on its merits with the Government. Back

78 Article 3 of the proposed Directive requires the Member States to criminalise a range of intentional conduct. The draft distinguishes between offences against the EU's "expenditure" and "revenue" and covers conduct in relation to both such as, the use of false, incorrect or incomplete statements, and non-disclosure of information. Back

79 Under Article 2 of the proposed Directive the EU's financial interest is defined as "all revenues and expenditures covered by, acquired through, or due to: (a) the Union budget; (b) the budgets of the institutions, bodies, offices and agencies established under the Treaties or budgets managed and monitored by them". Back

80 Penalties are dealt with under Articles 7-9 of the proposed Directive. Back

81 QQ 227 and 233 Back

82 Opinion 8/2012, 12 December 2012 Back

83 Opinion 8/2012, para 5 Back

84 Opinion 8/2012, para 7. The ECA suggest a clarification of the term "budget" so as to accommodate amongst others the European Central Bank. The ECA suggest that the clarification should "reflect the fact that the Union's financial interests relate to all assets and liabilities managed by or on behalf of the Union and its institutions, and to all its financial operations, including borrowing and lending activities". Back

85 Q 90 (Timothy Kirkhope MEP); Q 99 (Theodoros Skylakakis MEP) Back

87 Q 136 Back

88 Q 136 Back

89 In its Explanatory Memorandumwhich accompanied the proposed Directive the Government raised a number of concerns with the draft including (i) the imposition of minimum sentences, (ii) its interaction with existing EU legislation on the confiscation of the proceeds of crime into which the UK has not opted in (iii) the requirement that states would have to extend their jurisdictional rules extra-territorially to cover UK nationals; and (iv) the ramifications of the proposed legal basis of the Directive (Article 325 TFEU) which does not engage the UK's opt in protocol. Back