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Explanation of VAT Fraud and Its Consequences

VAT fraud refers to illegal activities that evade the collection or payment of Value Added Tax (VAT). This malpractice can occur at various stages of the supply chain and aims to maximize profits by exploiting weaknesses in the tax system. VAT fraud affects government revenues and undermines fair competition among businesses that comply with tax laws. Below are the key types of VAT fraud, methods used, and implications of such activities.

Key Types of VAT Fraud

1. Carousel Fraud (Missing Trader Fraud)

This is one of the most common types of VAT fraud associated with cross-border trade. It involves a chain of transactions where a business (the "missing trader") imports goods without paying VAT, sells them at a profit, collects VAT from the buyer, and then disappears without remitting the collected VAT to tax authorities. The goods are often sold through a series of transactions among various companies, creating a loop (or carousel) that makes it difficult for authorities to trace the fraud.

2. False or Fictitious Invoices

Businesses may create fake invoices for non-existent sales to claim input VAT refunds. This can also involve making transactions appear legitimate by falsifying the details of goods or services. This fraud type can occur in domestic and intra-EU trading situations.

3. Underreporting Sales

Some businesses may intentionally underreport their sales to minimize VAT liabilities. By failing to declare the full amount of sales, they avoid collecting the appropriate amount of VAT from customers and effectively reduce their tax obligations.

4. VAT Refund Fraud

This can occur when businesses claim VAT refunds based on fictitious or inflated expenses. By overstating costs or claiming input VAT on goods or services that were never purchased, they attempt to obtain refunds improperly.

5. Misuse of VAT Exemptions

Businesses might incorrectly categorize certain goods or services as exempt from VAT to avoid tax obligations. For example, misclassifying taxable commodities or services as zero-rated or exempt.

Implications of VAT Fraud

1. Financial Losses for Governments

VAT fraud leads to significant revenue losses for governments, which in turn can impact public services and infrastructure funding. This is particularly concerning given that VAT is a crucial source of revenue for many countries.

2. Unfair Competition

Businesses that comply with tax regulations face unfair competition from those engaging in VAT fraud. This can distort market dynamics, inhibit fair pricing, and ultimately harm compliant businesses.

3. Increased Scrutiny and Costs

Widespread VAT fraud prompts tax authorities to enforce stricter regulations and audit practices. This can lead to increased compliance costs for all businesses as they must navigate heightened scrutiny.

4. Legal Consequences

Engaging in VAT fraud can lead to severe legal consequences for individuals and companies involved, including hefty fines, additional assessments, and even criminal charges in serious cases.

5. Erosion of Trust

VAT fraud can undermine public trust in tax systems and government institutions, as citizens may perceive a lack of fairness and efficacy in tax administration.

Conclusion

VAT fraud is a serious issue that affects not only government revenues but also fair competition in the market. Various methods are employed to exploit weaknesses in tax systems, and governments worldwide are combating it with stricter regulations, enhanced enforcement measures, and increased cooperation among tax authorities. Businesses must remain vigilant and ensure compliance with tax laws to avoid the repercussions of both involvement in and victimization by VAT fraud. Combating VAT fraud requires a collaborative effort between tax authorities and compliant businesses to ensure the integrity of the tax system.

Personal liability

59 percent of respondents (53 percent in 2014) expect the personal liability of compliance officers to increase in 2015, with 15 percent expecting a significant increase. Compliance officers or its Executives at firms as diverse as Swinton Insurance, Bank Leumi, Bank of Tokyo-Mitsubishi, Brown Brothers Harriman and Deutsche Bank (DB: VAT fraud) have been fined, banned or jailed (or a combination).

Criminal charges and jail time

More often, tax and public prosecutors‘ offices file criminal charges for tax-related scenarios with consequences for nor only the businesses' reputation wise but also the executives and employees that could be jailed.

Prosecutors said they were investigating 25 bank staff on suspicion of severe tax evasion, money laundering and obstruction of justice, and searched the headquarters and private residences in Berlin, Düsseldorf and Frankfurt.

 "Two of Deutsche Bank's Management Board members Juergen Fitschen and Stefan Krause are involved in the investigations as they signed the value-added tax statement for 2009," Deutsche Bank (DBKGn.DE) said in a statement. 

Control and anti-fraud

VAT fraud is high on the European Union's political agenda: though the exact amount of money involved is difficult to quantify, some Member States have estimated their losses at up to 10% of net VAT receipts.

If a business charges you VAT, it must be VAT registered and must declare any VAT it charges to HMRC. Some businesses deliberately avoid registering for VAT, thereby gaining an unfair advantage over their competitors. Others may either be bogus or may lie about the amount of VAT that they owe.

You might know that a business is not declaring all the VAT they’re charging, or you might think that they’re not because they:

  • ask you to pay them in cash and are reluctant to provide an invoice
  • request that payment is made to someone other than the business
  • offer a discount for cash and are reluctant to accept checks or credit cards
  • offer goods for sale at substantially below market value
  • put money into an open till drawer without ringing up a sale

Missing Trader Intra-Community VAT fraud

‘Missing trader’ fraud involves obtaining a VAT registration number in the UK for the purpose of purchasing goods free of VAT in another EU Member State. These goods are then sold in the UK at a VAT-inclusive price. After which, the trader will go missing or default, without paying the VAT due to HMRC. Another form of this type of fraud is called ‘carousel fraud’. This involves trading the same goods around contrived supply chains within and beyond the EU. The goods will re-enter the UK on a number of occasions with the aim of creating large unpaid VAT liabilities and fraudulent VAT repayment claims.

Estimated the amounts of fraud

A European Union study (2013) says the bloc's 28 member nations may be losing almost 200 billion euros ($267 billion) annually in value-added tax revenues due to tax evasion and a lack of enforcement.

EU Tax Commissioner Algirdas Semeta said the amount of revenues slipping through the governments' nets is "unacceptable, particularly given the impact such sums could have in bolstering public finances." 

The study for the European Commission, the bloc's executive arm, found member states lost an estimated 193 billion euros ($258 billion) in VAT revenues in 2011, or 1.5 percent of the EU's economic output.

Urgent measures to tackle the VAT Gap

The ’VAT gap’ between expected revenue and revenue actually collected by national authorities is estimated at EUR 170 billion, which equates to 15.2% of revenue loss. This calls for urgent action on several fronts:

  • Improving cooperation within the EU and with non-EU countries
  • Towards more efficient tax administrations
  • Improving voluntary compliance
  • Tax collection

Some examples of 2012

“Nasir Khan had a successful accessories business, a jet-set lifestyle and a reputation as a pillar of the community. But all that vanished in December when he was jailed for his part in a £250m VAT fraud. Jasper Jackson discovers how a 10-year investigation by HMRC led to his downfall. By Jasper Jackson – Mobile News  March 2012

“Two men have been jailed for their role in a plot to smuggle nearly 24 million counterfeit cigarettes into the Midlands, following an investigation by HM Revenue & Customs (HMRC). The conspiracy would have seen nearly £4 million drained from the UK economy through duty evasion.” HM Revenue & Customs, March, 2012

“A 34-YEAR-OLD man was yesterday convicted of a €680,000 VAT fraud after a 10-day trial that heard he produced 141 bogus invoices on non-existent transactions with imaginary subcontractors.” By Gordon Deegan – Irish Times.com, March 2012

“A 64-year-old man has been arrested in a dawn raid into a £1 million suspected VAT fraud involving a Workington business.” News & Star, January 2012

“Yacht broker jailed over VAT fraud – A Dorset yacht broker who charged £210,000 VAT on the sale of six luxury yachts and then pocketed the cash has been jailed. James Williams, 51 was found guilty on six counts of cheating the public revenue and one count of false accounting. He was sent to prison for three years. John Cooper, HMRC Assistant Director Criminal Investigation, said: Williams used his position as director of a yacht brokers to commit VAT fraud. He sold boats which had previously been supplied VAT-free for export to the Channel Islands, but failed to account for the VAT on their subsequent sale in the UK. This blatant attack on the tax system not only robbed the Exchequer of public funds, but is also unfair to those businesses that diligently abide by the rules. Tackling VAT fraud is a priority for us, and we will not hesitate to pursue those who commit this type of offense. Anyone who has information about suspected VAT fraud can call the Customs’ Hotline on 0800 59 5000” By Dick Durham of Yachting Monthly, March 23, 2012

“An antique jewelry trader who fraudulently claimed over £1.6 million in VAT repayments by creating fake invoices for expensive Rolex and Cartier watches has been jailed. Jonathan Uri Shohet (45) of Baldock, Herts, used stolen invoice books and fake invoices to claim back VAT from HM Revenue & Customs (HMRC) but had never purchased many of the watches he claimed repayments for.” HM Revenue & Customs, April 25, 2012   

Ten Reasons Frauds Occur

  1. Greed – good old-fashioned human nature intervenes when an individual, or group of individuals, sees a chance to make “a fast buck”. A good example being those cases where people “adjust” their expense claims upwards.
  2. Lack of transparency - complex financial transactions that are difficult to understand are an ideal method to hide a fraud. The Barings fraud was perpetrated by use of an accounting “dump account” that no one understood.
  3. Poor management information – where a company’s management information system does not produce results that are timely, accurate, sufficiently detailed and relevant; the warning signals of a fraud, such as ongoing theft from the bank account, can be obscured.
  4. Excessively generous performance bonus payments – the more generous the bonus, when coupled to a demanding target; the more temptation there is to manipulate results, such as year-end sales figures, to reach that target.
  5. Non-independent internal audit department – where an organization’s internal audit department is not independent, eg the where it does not report to a truly independent audit committee but to the Finance Director, the more likely that when there are signals that a fraud is occurring the more likely they will be ignored. It is indeed interesting to note that Cynthia Cooper (Head of Internal Audit at WorldCom) had to bypass her boss (the CFO) and go directly to the audit committee to report the discovery of the capital expenditure fraud.
  6. Lack of clear moral direction from senior management – leadership comes from the top. Where the senior management indulge themselves in “semi corrupt” behavior, eg adjusting their expense claims upwards, others will follow, adopting the well worn mantra “everyone’s at it”.
  7. Excessively complex organizational structure - designed to obfuscate the revenue streams, and so hide reality from third parties, such as the Internal Revenue Service. Enron, with its complex off balanced sheet structure and transactions, is a textbook example of this.
  8. Poor accounting controls– where the accounting controls, such as a monthly reconciliation of the bank account, are lapsed the signals that a fraud has occurred will be missed.
  9. Arrogance – some people believe that they are better than “the system”, and that they can get away with anything. The late Robert Maxwell (of the Mirror Group) plundered his company pension scheme, arrogantly assuming that since he was chairman of the company he could get away with it; he almost did!
  10. Complacency – I have met many a manager who has an almost childlike faith, based in part on the “old boy” network, in the probity of their colleagues; believing that fraud “is not the sort of thing that could happen here”. Others will, and do, take advantage of that trust. From: Ten Reasons Frauds Occur