• VAT FRAUD IN EUROPEAN UNION
    HOW TO FIGHT BACK

    By Ksenija Cipek

    19-07-2019

    Author: Ksenija Cipek in collaboration with Dr Manuel Pereira.

    I INTRODUCTION

    The size of the VAT fraud is difficult to measure in itself. One of the most commonly accepted indicators used pointing to the scale of the problem is the ‘VAT gap’. It estimates the overall difference between the expected VAT revenue and the amount actually collected. It should be noted however that the VAT gap provides an estimate of revenue loss due not only to fraud and evasion, but also weaknesses in national tax collection systems, lack of compliance of taxpayers leading to a shadow economy, impediments in the enforcement of the tax obligations by tax authorities, for instance a lack of tax audits carried out by tax administration, insolvencies as well as miscalculations and other irregularities. Despite its imperfections, the VAT gap offers a useful indicator to assess the size of VAT that is not collected by Member States.1

    According to the Study and Reports on the VAT Gap in the EU-28 Member States: 2018 Final Report, EU countries lost almost €150 billion in Value-Added Tax (VAT) revenues in 2016, according to a new study published today by the European Commission. The so-called 'VAT Gap' shows the difference between the expected VAT revenue and the amount actually collected. In nominal terms, the VAT Gap decreased by €10.5 billion to €147.1 billion in 2016, a drop to 12.3% of total VAT revenues compared to 13.2% the year before. The individual performance of the Member States still varies significantly. The VAT Gap decreased in 22 Member States with Bulgaria, Latvia, Cyprus, and the Netherlands displaying strong performances, with a decrease in each case of more than 5 percentage points in VAT losses. However, the VAT Gap did increase in six Member States: Romania, Finland, the UK, Ireland, Estonia, and France.2

    II TERMINOLOGY3

    VAT evasion generally comprises illegal arrangements where tax liability is hidden or ignored, i.e. the taxpayer pays less tax than he/she is supposed to pay under the law by hiding income or information from the tax authorities.

    VAT fraud is a form of deliberate evasion of tax which is generally punishable under criminal law. The term includes situations in which deliberately false statements are submitted or fake documents are produced. It is organised fraud and includes national and cross border transactions.

    MTIC fraud is a specific form of VAT fraud. VAT is stolen from a government by organised criminal activity, which exploits cross border trading where the movement of goods between jurisdictions is VAT-free. This allows the fraudster (the person who commits fraud) to charge VAT on the sale of goods, and then instead of paying this to the government's collection authority, simply disappear, taking the VAT with him.

    The Missing Trader (MT) is a (fictitious) company employed to simulate an intra Community transaction in order to obtain a fraudulent gain from VAT charged on a subsequent transaction. When it is time to pay the VAT to the tax authorities the MT disappears.

    The Buffer Company (BC) is an entity that acts as a normal trader, purchasing and supplying goods and/or services on the domestic market. It is employed in the fraud chain after the MT to hide the fraud scheme and make investigations more difficult.

    The Broker (BR) is the final link of the fraudulent scheme and is situated in the same Member State as the MT. It purchases goods and/or services from the BC and supplies them to an operator established in the domestic market or in another Member State. In case it makes an IC supply, it will claim for the refund of the VAT paid on its purchases.

    The Conduit Company (CC) is a trader that participates in a transaction that is connected with the fraudulent evasion of VAT in another Member State.

    III SCHEMES AND CASES OF FRAUD

    1. Company A (so-called "conduit company") in MS 1 sells goods to company B (MT) in MS 2. The intra-Community sales (ICS) is VAT exempt. The purchase is made without payment of VAT. Company B charges and receives VAT on sales to company C (so-called "broker company"). Company B disappears without having declared and remitted the intra-Community acquisition (ICA) and the charged VAT to the tax authorities. Subsequently, company C sells the goods back to company A. As the ICS is VAT exempt and he is allowed to deduct the input VAT charged by company B, company C will receive a refund of VAT from the tax authority. When company C makes the ICS to company A the commercial chain is closed and can eventually restart.

      Source and graphics of the scheme 1.: European Commission, The concept of Tax Gaps Report III: MTIC Fraud Gap estimation methodologies, Directorate-General for Taxation and Customs Union FISCALIS 2020 Tax Gap Project Group, subgroup VAT fraud (FPG/041), 2018

    2. The Contra-Trading scheme is a complex scheme in which various transactions chains are introduced to make VAT fraud difficult for the tax authority to discover.

      The keystone of the fraud scheme is company C, the contra trader in MS 2. This company makes two acquisitions: (1) a domestic purchase from the MT (company B) which in turn had acquired IC goods from company A in MS 1 without paying VAT; and (2) an ICA from company D in MS1. The MT in MS 2 disappears without paying VAT to the treasury on the goods sold. 13 Then, the contra trader makes two supplies: (1) an ICS - related to the fraudulent chain - to company G in MS 3; and (2) a domestic supply- not directly related to the fraudulent chain- to company E which in turn makes an ICS to company F in MS 3. MS 2 suffers VAT losses due to both VAT unpaid by the missing trader and VAT refunds direct, from company C, or indirect, from company E, linked to the fraud.

      Source and graphics of the scheme 1.: European Commission, The concept of Tax Gaps Report III: MTIC Fraud Gap estimation methodologies, Directorate-General for Taxation and Customs Union FISCALIS 2020 Tax Gap Project Group, subgroup VAT fraud (FPG/041), 2018

    3. The missing trader and the missing broker were put in place by criminals in the only purpose to evade VAT in France. There was a double failure to remit the VAT to the tax administration from the missing trader (company B) and from the missing broker (company C). At the end, huge volume of carbon certificates were purchases VAT free and resold VAT included to the final beneficiary broker (company D). There was various situations possible ranging from the single criminal involvement of company B and C to complicity of all companies all along the trade chain from A to E.

      Payments from the beneficiary D (including VAT) were channelled to bank accounts held by the missing trader in other Member States, and the money ended on bank accounts held in Hong Kong.

      The natural persons having set up the fraudulent scheme were well-known VAT fraudsters associated with other persons well-known members of Parisian and Marseille's organised crime networks.

      In this context, four persons involved in this VAT carousel were assassinated in Paris, very likely due to the attractiveness for organised crime for the gains generated by this large-scale VAT fraud.

      The industrial scale of the fraud in the given sector:
      This specific fraudulent scheme generated a damage amounting to EUR 1.7 billion at the detriment of French national budget, while it would represent EUR 5 billion of lost for national and EU budget at European level in 2008-2009.

      It is worth mentioning that in June 2016, the decision to apply an exemption of VAT onto carbon certificates trading triggered a 90% drop of the volume of exchanges onto the market place. Same money laundering patterns as those used by traditional organised crime networks:

      Proceed of crime was partially reinvested in the carbon VAT carousel, and partially laundered via bank accounts held by the missing trader or by natural persons in Hong Kong.

      Funds were finally put at the disposal of the criminals via a specific money laundering scheme consisting in banking transfers from the missing trader bank accounts to companies which were in charge of disbursing cash money to be remitted to the fraudsters in compensation. These money laundering commercial entities located in Latvia, China, Hong Kong and Liechtenstein charged a 2% fee for this service.

      Another money laundering pattern was detected with the use of a legal entity registered in Panama holding a bank account in Turkey on which EUR 38 million coming from the VAT carousel fraud were transferred. This amount was then transferred to bank accounts in United Arab Emirates and in Latin America to companies well-known for having been also used by Colombian drugs cartels for money laundering purposes.

      Results obtained:

      Out of EUR 1.7 billion, judicial investigations carried out by the French Judicial Customs Service brought about seizure of EUR 116 million and 100 indictments. The case considered as the biggest VAT carousel fraud ever dismantled in Europe is currently pending before the Tribunal Correctionnel de Paris (June 2017).

      VAT carousel fraudsters tend not only to contaminate new specific economic sectors, but also tend to involve institutional players acting onto these markets: the cases of precious metals and plastic markets.

      VAT fraudsters contaminating the copper cathodes sector:

      Judicial investigations highlighted the great adaptability of these criminal networks for moving the VAT fraud from one economic sector to the other, and from one Member State to the other, always with the same missing trader located in France.

      In this respect, one investigation demonstrated that the same company was successively used in fraud involving green certificates in Italy in 2010, in a carousel VAT fraud onto electricity sector in Slovakia and finally in a MTIC VAT fraud onto the copper market in France.

      In the latter, the criminal network managed to impose the company as a key player onto the very specific and closed copper cathodes market where only well-known professionals are acting. A significant volume of copper was bought by a Swiss trader in Chili and stored in Rotterdam in line with the London Metal Exchange (LME) standards. The missing trader company bought several hundreds of thousands tons of copper VAT free from this trader and resold it VAT included at a loss (at a very competitive price) to a French player onto the market. At the end, the copper cathodes were sold to a French large business.

      Sale at loss to its French client was largely compensated by the profit derived from the VAT evasion in the trade chain. In this case, EUR 1.2 million were not remitted to the tax administration in France. Proceeds of crime were laundered through international bank transfers from the missing trader to Chinese companies which took care of disbursing cash money remitted to the fraudsters via Chinese natural persons living in France.

    4. Source and graphics of the case 2.: COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT, Accompanying the document, Amended proposal for a Council Regulation, Amending Regulation (EU) No 904/2010 as regards measures to strengthen administrative cooperation in the field of value added tax {COM(2017) 706 final}{SWD(2017) 429 final}, (2018)

    IV HOW TO FIGHT BACK

    a) E-COMMERCE – CHALLENGE4

    The EU’s new ‘e-commerce package’, proposed by the European Commission on 1 December 2016 and adopted by the European Council at the end of 2017, is aimed at addressing these issues. The package of legislation was drawn up within the framework of the Strategy for the EU Digital Single Market. On the VAT e-commerce proposal, first reforms will come into effect on 1 January 2019. Other measures will come into place in 2021.

    In general terms, EU customs law is laid down in the Union Customs Code7, while VAT is governed by the EU VAT Directive. A new package of specific EU legal provisions governing VAT in e-commerce, the ‘e-commerce package’, was adopted at the end of 2017. This represents the first attempt to address directly in legislation the issue of VAT and customs duties in e-commerce. The package consists of three legal acts and introduces the following changes:

    • It allows micro-businesses and start-ups to tax their supplies of e-commerce services not exceeding the threshold of €10 000 according to the ‘origin principle’, i.e. at the rate of the Member State of origin, not the Member State of destination.
    • It allows e-sellers to apply the invoicing rules of their Member State of identification instead of the rules in force in the Member State of destination, as they currently do.
    • It extends the MOSS system to all cross-border B2C supplies of services and to online B2C sales of goods, whether from an EU or non-EU country.
    • It abolishes the VAT relief for items not exceeding a total value of €22 (or €10) purchased online and imported from a non-EU country. Some of these changes will come into effect from 1 January 2019, while the rest will only apply from 1 January 2021.
      The plan forms part of the Commission’s Digital Single Market strategy. Its main aim is to make the EU’s VAT system simpler, more fraud-proof and more business-friendly, providing for the following improvements in respect of VAT on e-commerce:
    • strengthening cooperation in the fight against fraud within the EU and with non EU countries;
    • introducing a common EU-wide simplification measure (VAT threshold) to help small e-commerce start-up businesses;
    • allowing for home-country checks, including a single audit of cross-border businesses;
    • removing the VAT exemption for imports of small consignments from non-EU suppliers;
    • extending the One Stop Shop mechanism to EU and non-EU countries online sales of tangible goods to final consumers;
    • a definitive VAT regime for intra-EU trade based on the destination principle.

    b) CURRENT EU REGULATORY FRAMEWORK TO TACKLE VAT FRAUD5

    1. LEGISLATION

    Recovery assistance directive - To close this gap between substantive and enforcement jurisdiction, the Member States have adopted Council directive 2010/24/EU of 16 March 2010 concerning mutual assistance for the recovery of claims relating to taxes, duties and other measures. This instrument applies for the recovery of any taxes in another Member State, including VAT.

    Assessment assistance regulation - The Member States also committed to exchanging information that is relevant for the correct assessment and collection of VAT, in accordance with Council regulation 904/2010 of 7 October 2010.

    Quick reaction mechanism - Articles 199a and 199b of the VAT Directive (introduced by Council Directive 2013/42/EU of 22 July 2013) allow Member States to quickly react to cases of massive fraud, in particular carousel fraud.

    Criminalisation of fraud to the Union’s financial interests - VAT fraud directly affects the EU financial interests because part of Member States’ VAT revenue is an EU own resource. Accordingly, the Member States have committed to criminalise forms of preparation and of participation in VAT fraud with the adoption of Directive 2017/1371 of the European Parliament and of the Council of 5 July 2017 on the fight against fraud to the Union's financial interests by means of criminal law.

    CJEU case law - The Court of Justice of the European Union (CJEU) is playing a key role in the development of the EU VAT system by providing harmonised interpretations of the VAT Directive. In the past decades, the CJEU also clarified the consequences in the case of VAT fraud in the supply chain.

    2. EU BODIES, COMMITTEES AND PROGRAMMES

    EUROFISC - Eurofisc was established by Council Regulation 904/2010 of 7 October 2010 with the objective to promote and facilitate multilateral cooperation in the fight against VAT fraud.123 It functions as an early warning system: Eurofisc liaison officers communicate information regarding suspicious activities detected in the course of domestically-led risk analyses.

    OLAF - OLAF is a supranational and independent body in charge of carrying out ‘administrative investigations’ to step up the fight against fraud, corruption and any other illegal activity affecting the financial interests of the European Union. It has autonomous powers to open and conduct investigations, gather evidence, and draw recommendations. ‘However, OLAF lacks coercive power, and therefore relies upon the assistance of the national law enforcement offices, whenever it is needed, during its activities on a Member State (or third country) territory.’

    EUROPOL - Europol was created by Council Decision 2009/371/JHA in order to ‘support and strengthen action by Member States and their mutual cooperation in preventing and combating organised crime, terrorism and other forms of serious crime affecting two or more Member States.’ Europol also works with some non-EU partner states and international organisations.

    European Public Prosecutor Office (‘EPPO’) - currently, only national authorities can investigate and prosecute fraud against the EU budget. However, their powers stop at national borders. As to existing EU-bodies such as Eurojust, Europol and OLAF, they lack the necessary powers to carry out criminal investigations and prosecutions.133 The establishment of the EPPO134 should bring a solution to that situation. Once implemented, the EPPO will ultimately have the power to carry out criminal investigations and prosecutions in currently 22 participating Member States (while OLAF will continue to conduct administrative investigations into fraud, corruption and any other illegal activity affecting those interests in the whole EU).

    EUROJUST - the role of Eurojust is to ‘support and strengthen coordination and cooperation between Member States’ investigating and prosecuting authorities in relation to serious crime affecting two or more Member States, or requiring a prosecution on common basis. Eurojust works on the basis of operations conducted and information supplied by the Member States and by Europol.’

    FISCALIS - a multiannual EU action programme was established in 2013, the so-called ‘Fiscalis Programme’, with the objective ‘to finance initiatives by tax administrations to improve the operation of the taxation systems in the internal market’. This programme has recently been extended to 2020. The regulation setting up Fiscalis 2020 insists even more clearly on the objective of supporting the fight against tax fraud, tax evasion and aggressive tax planning.145 Fiscalis project groups are composed of experts from Member States.

    VAT Expert Group and VAT Forum - since 2012, the European Commission and the Member States also receive technical input from the private sector via the VAT Expert Group and the VAT Forum. The VAT Expert Group is composed of businesses, tax practitioners and academics. Together, they discuss legislative proposals made by the European Commission. The VAT Forum is composed of the Member States and a selection of businesses. Together they discuss practical issues with the current legislation. In both groups, current or future risks of fraud and ways to mitigate them are being discussed.

    3. PROPOSALS TO IMPROVE CURRENT REGULATORY FRAMEWORK

    The Member States are currently discussing a possible shift towards a definitive VAT system based on the destination principle. One of the main objectives of the proposed reform is to curb MTIC /carousel fraud. Interim measures were also adopted to improve the current system, pending the entry into application of the definitive system, together with the possibility to apply a General Reverse Charge Mechanism in specific situations and under specific conditions. The assessment assistance directive will also be updated in order to curb Customs Procedure 42 and VAT fraud related to cars (which would not be solved with the definitive system) through a more efficient exchange of information. Pending the adoption of the definitive system, an improved information exchange framework should also allow carousel/MTIC types of fraud to be better addressed. Finally, the European Commission might propose the exchange of VAT-relevant payment data, in order to better monitor the collection of VAT on online sales and detect non-compliant taxable persons.

    V CONCLUSIONS

    Fraud in the area of VAT will not disappear, will become more sophisticated, especially in the era of digital evolution. However, a number of EU-implemented measures or anti-fraud proposals are conducive to the struggle of member states against the deceased.

    The development of new anti-VAT fraud tools at EU level further narrows space for fraudsters.

    The possibilities of using new technologies such as Blockchain and Distributed Ledger Technology should also be considered.

    Member States can also reduce tax fraud through a sophisticated Compliance Risk Management System that allows quick recognition of the most risky taxpayers.

    The development and implementation of predictive analysis allows for the recognition of the behavior of taxpayers deferred to tax fraud before that happens.

    The exchange of data between Member States and other countries is a vital factor in preventing fraud.

    "Tax me if you can" is still a danger, but maneuvering space becomes all the more complicated and demanding for fraudsters.


    1. https://ec.europa.eu/transparency/regdoc/rep/10102/2017/EN/SWD-2017-428-F1-EN-MAIN-PART-1.PDF
    2. https://ec.europa.eu/taxation_customs/news/vat-gap-report-2018_en
    3. https://ec.europa.eu/taxation_customs/sites/taxation/files/tax-gaps-report-mtic-fraud-gap-estimation-methodologies.pdf
    4. https://www.eca.europa.eu/Lists/ECADocuments/BP-VAT/BP-VAT-EN.pdf
    5. http://www.europarl.europa.eu/cmsdata/156408/VAT-20Fraud-20Study-20publication.pdf
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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

Ksenija Cipek

Ksenija Cipek is based in Zagreb, Croatia and she is a lecturer at the local University of Law and a Member of European Law Institute. Ksenija has over 20 years experience working at the Ministry of Finance and the Tax Administration. She is a highly respected and recognised tax expert who has been heavily involved in lawmaking. Ksenija is also an author and books writer.

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