Value Added Tax Fraud

Marius-Cristian Frunza

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781351580960
• Edition: 1
• Topic: Law
• Subtopic: Financial Law
• Index: Law

Serving as an introduction to one of the "hottest" topics in financial crime, the Value Added Tax (VAT) fraud, this new and original book aims to analyze and decrypt the fraud and explore multi-disciplinary avenues, thereby exposing nuances and shades that remain concealed by traditional taxation oriented researches. Quantifying the impact of the fraud on the real economy underlines the structural damages propagated by this crime in the European Union. The 'fruadsters' benefit when policy changes are inflicted in an economic space without a fully fledged legal framework. Geopolitical events like the creation of the Eurasian Union and 'Brexit' are analyzed from the perspective of the VAT fraud, thereby underlining the foreseeable risks of such historical turnarounds. In addition, this book also provides a unique collection of case studies that depict the main characteristics of VAT fraud.

Introduction to VAT Fraud will be of interest to students at an advanced level, academics and reflective practitioners. It addresses the topics with regards to banking and finance law, international law, criminal law, taxation, accounting, and financial crime. It will be of value to researchers, academics, professionals, and students in the fields of law, financial crime, technology, accounting and taxation.

1 Introduction to the mechanisms of VAT fraud

VAT: a European concept

VAT rules are a quarter of a century old and no longer fit for purpose. Fraud today is not something citizens can accept any more, particularly when it finances organised crime and terrorists.

Pierre Moscovici, European Union Commissioner, 2017¹

Tax can be defined as a financial liability established and collected by a government or an equivalent agency. The government of a country can apply tax levies to income, capital, resources, labour, goods and services. Tax concerns all physical and moral persons encompassed by the jurisdiction of a government.

Taxes are the main source of revenue for the national budget of a country or region. They are classified as direct taxes and indirect taxes. Direct taxes are charged directly on the income or wealth of the person, while indirect taxes are imposed on the price of goods and services. The computation of tax levy has, in general, two main components:

• the tax levy base, representing the nominal value upon which the assessment of tax liability is made, and
• the tax rate, which is presented generally as a percentage.

Value Added Tax (VAT) is an indirect consumption tax, charged on most trades of goods and services. The base of the VAT is the value added by the economic agent. For example an industrial company purchasing raw materials for 100 euros and transforming them into a finite product sold for 130 euros has a VAT liability on the 30 euros of value added in the production process.

A wholesaler buying clothes for 1,000 euros and selling them to retailers for 1,500 euros is liable on the 500 euros of commercial value added. VAT is charged to registered businesses and final non-business customers. Final clients do not pay the VAT directly to the government but to B-to-C (business to client) companies. B-to-C companies registered for VAT pay their liability periodically (generally quarterly) to the tax office of the country where the product is consumed. B-2-B (business to business) companies are also liable for VAT, depending on the difference between VAT charged to clients and the VAT paid for purchases. If the balance is negative the company can claim a refund from the tax office. If the balance is positive the business is required to pay the tax levy to the concerned national treasury.

The concept of VAT was fathered in the 1950s by Maurice Lauré (Laure, 1955). He was the head of the French Tax Authority. VAT was introduced in France through a law on 10 April 1954.

VAT (TVA, Taxe sur la valeur ajoutée) was first tested in Ivory Coast (Côte d’Ivoire), a French colony, in 1954. After the Ivorian experiment, VAT was extended to the entire French territory in 1958. Rapidly, the concept of VAT spread to other European countries.

After the collapse of the former communist bloc and the dismantlement of the Soviet Union in August 1991, major policy reforms were immediately implemented in the former Eastern Bloc, aiming to regulate the exponentially rising economic activities.

VAT (НДС, налог на добавленную) was introduced in Russia in 1992. It is administered by the Federal Tax Service, with a rate of 18% for most goods and services. In 1993, VAT was also introduced in Romania (TVA, Taxa pe Valoare Adaugata), while Bulgaria adopted VAT (ДДС, Данък върху добавената стойност) in 1994. China started to implement VAT gradually between 1984 and 1993, when the State Council promulgated a dedicated policy. The United Arab Emirates and Saudi Arabia adopted VAT as of 2018, with a small rate of 5% that is supposed to increase over time.

Goods and Services Tax (GST) is an equivalent of the VAT implemented in countries like India, Canada, Australia and New Zealand. By the early 2000s, VAT had become the key component of the indirect taxation systems in more than 120 countries, with tax rates varying from 5% to 27%.

Interestingly, the VAT failed to find acceptance in the United States, despite numerous attempts by various politicians to bring momentum around the introduction of the VAT as a Federal tax. Michigan adopted a modified VAT, named a Business Activities Tax, and used the system for 14 years. The United States is, along with a few financial paradises (i.e., the British Virgin Islands, the Cayman Islands, Gibraltar and Guernsey), amongst the only states in the world without a VAT system.

Tax fraud

The separation line between tax compliance and tax fraud is very murky. When a company or an individual looks for leeways from the normal avenue of being fully compliant with all tax liabilities, few legal options are available.

1. Tax optimization consists of adjusting the various financial metrics comprising a base for tax levies in order to minimize the total tax liability. A simple example is using debt in corporate as a means to reduce the corporate tax bill.
2. Tax arbitrage profits from the way a given transaction is taxed in different countries or different regions of a country. VAT for example has various rates in different countries. Within the same country a region (i.e., Livigno in Italy) could be exempted of tax.
3. Tax avoidance is the practice that employs legal methods in order to aggressively reduce tax liability by claiming deduction or refunds. Tax avoidance can employ sophisticated structures like offshore holdings and structured financial products, like insurance or derivatives, designed to enhance tax avoidance.

Tax evasion is employing illegal methods to reduce partially or totally the tax liability or to access fraudulently tax reimbursement from the national tax office.

By its very nature, VAT’s effectiveness relies on the integrity and loyalty of various intermediaries that collect and pay the tax along the economic chain. On the one hand, economies with ‘black markets’ involving undeclared trades are not submitted to VAT, thereby reducing its base and constituting a source of tax evasion. On the other hand, defecting intermediaries in distressed financial situations or unfaithful (missing) traders vis-à-vis a tax discipline represent a second source of evasion.

VAT evasion touches all countries having indirect taxation systems, including both VAT and GST. If most often the cases from the European Union (EU) or the United Kingdom are reported, VAT fraud occurs also in Australia or the Russian Federation. Countries from the African continent like South Africa were also touched. In 2018,² the South African Revenue Service and crime intelligence officers arrested eight men and a woman in connection with a scam with a potential loss to the taxpayer of more than 90 million rans (5.7 million euros). The gang was also associated with violent crimes.

In January 2018 the United Arabs Emirates and Saudi Arabia introduced VAT in their taxation systems. Despite being a source of structural risk for the global trade, VAT is definitely a stable source of income for the national budget. Dubai is already an international hub for financial crime, and the introduction of VAT will most likely make the Emirates more attractive for crooks.

VAT fraud typologies

Tax fraud appears in many forms and shapes, touching multiple markets and sectors of the economy. As pointed out before the borderline between tax fraud, tax avoidance and tax optimization is not well defined and can swing, depending on the interpretation of national laws and regulations. Therefore, any classification of VAT fraud typologies needs to be apprehended cautiously and might not be consistent in regards to both legislation and economic reasoning. Without loss of generality, one can split the economy of a country into two major silos:

• The formal economy, represented by those economic activities governed by the national law and with observable and quantifiable turnover figures. Traditionally, the formal economy is established on organized commercial entities registered with the national business registries. The size of the formal economy is measured from compulsory reports required by governments from businesses, including tax fillings, financial annual statements, etc.
• The informal or the shadow economy, encompassing all trades of goods and services taking place outside the perimeter of national laws. The volumes and the values of the trades for the shadow economy are in most of the cases not directly observable. The output of the shadow economy is not included in the base of any national tax.

Based on these considerations, the following empirical classification of VAT fraud typologies is proposed:

1. Shadow economy-related VAT fraud encompasses the undeclared domestic and cross-border trades of goods and services not submitted to VAT.
2. Dissimulation of trades from formal economy is known as Missing trader fraud. The Missing trader’s aim of concealing the totality or part of the turnover is to underestimate the base of the VAT and to pay less or not to pay the full value of the liability towards the national treasury. The missing trader ‘disappears’ after a relatively short period of time by closing, abandoning or bankrupting the business.
3. Misrepresenting the figures from the trading book of an organization by employing Accounting shenanigans aim to artificially reduce the amount of VAT liabilities, without altering the rest of the accounting figures. The accounting shenanigans can be used over an extended period of time, without ceasing the business, as in the case of the missing trader.
4. Misrepresenting the type of traded goods or services aims to reduce the VAT liability by applying an inappropriate VAT rate lower than required. Misrepresentation of goods and services entails declaring for taxation purposes an item in a category different from the correct one in order to arbitrate the VAT rate percentage.

The shadow economy

The base of the value added taxation is represented by the formal economy. Thus, the shadow economy is inevitably linked to tax fraud and especially to VAT fraud. The trades taking place within the shadow economy are not declared for any tax purpose, thereby the...