How to fight VAT fraud: The 147th mBank-CASE seminar

The 147th mBank-CASE Seminar was devoted to methods of fighting fraud and abuse in VAT payments. The main presentation, titled How the European Commission and European countries fight VAT fraud, was delivered by Dr. Tomasz Michalik, one of Poland’s leading specialists on VAT. Comments were also presented by Tomasz Kassel of PwC and Piotr Laskowski of the Internal Security Agency (ABW).

VAT fraud and abuse: mechanisms and causes

Dr. Tomasz Michalik, an attorney, tax adviser and partner at MDDP Michalik Dłuska Dziedzic i Partnerzy, presented the basic areas of VAT abuse, as well as the actions of the European Commission and member states aimed at preventing VAT-related fraud. Dr. Michalik cited Europol estimates that on the scale of the entire European Union, VAT fraud has cut budget revenues by as much as EUR 60 billion in recent years. Additionally, VAT fraud makes up a significant proportion of the VAT compliance gap (discussed in more detail in a CASE report).

The basic areas of abuse are domestic trade (“traditional” fraud and abuse, unregistered transactions) and intra-EU trade. Within intra-community trade, one of the most spectacular and frequent methods of fraud is the so-called carousel transaction, featuring a disappearing taxpayer. The missing trader acquires goods from a seller in another country, who does not charge the tax, taking advantage of the ability to declare a 0 percent rate. Next, the fraudster brings the goods into their country, not paying the VAT that is due. In the next stage, this entity sells the goods to another taxpayer, usually one who is unaware of the fraud (the so-called buffer), adding VAT, and then disappears without sending the tax due to the state budget.

The cause of the great scale of fraud and abuse is the artificial structure of the two transactions in intra-EU trade, of which one is taxed at 0 percent, and added to this is the lack of appropriate control procedures and harmonized reporting requirements. A further reason pointed out by Dr. Michalik, a member of the VAT expert group appointed by the European Commission, is that EU member states often don’t show any willingness to work together on the fight against VAT fraud.

VAT frauds are exceptionally attractive for organized criminal groups: frauds of this type bring high profits and carry low risk. According to Dr. Michalik, criminal groups are responsible for 80 percent of carousel transactions, so leaving the question of prosecuting such crimes exclusively to tax administrations may be doomed to fail. There is a need for tighter cooperation between tax administrations and investigative agencies.

European Commission and EU member state actions aimed at preventing VAT fraud

The European Commission is working on new legal instruments to improve the exchange of information and cooperation between member states for more effective prosecution of VAT-related crime. The EC is also working toward introducing a new, simplified settlement model for intra-community transactions. The “Single VAT Area” concept proposed by the Commission calls for the unification of the method of taxing intra-EU transactions and those in individual member states. This would make it possible to eliminate fraud based on the ability to declare a 0 percent rate (exemption) and receive a return of the tax paid. If this model of taxing transactions took effect, each transaction inside the EU would be taxed only in the destination country. The taxpayer would be the supplier, who would be obligated to register in the destination country. In practice, this means that a Polish company exporting to Germany would have to register in Germany and settle VAT with the German tax authority.

The procedure of a single registration in the supplier’s state is already applied in the case of telecommunications, broadcasting or electronic services for private individuals from other EU countries (the so-called Mini One Stop Shop), and according to the Commission, it works well. The EC estimates that a new, universal system could cut the level of VAT abuse in the area of the entire EU by 83%. The Commission will present a precise legislative proposition in 2017. The most difficult element of the model promoted by the EC is the question of cooperation between tax authorities of various member states, and specifically northern European states’ lack of trust in the effectiveness of southern states’ tax administrations and investigative agencies.

Not waiting for the Commission’s proposal, individual member states have introduced a whole range of mechanisms to fight VAT abuses, e.g. split payments in the Czech Republic, Italy and Greece, and a central registry of invoices in Portugal. According to the EU, one of the most effective methods of fighting VAT fraud is the reverse charge mechanism, meaning the supplier or service provider issues an invoice for the net value, and the VAT is added by the purchaser of the product or service (in B2B transactions). The reverse charge mechanism can be introduced for supplies of construction services, trade in used materials, waste and real estate.

Dr. Michalik finished his presentation by noting that 2017 will be key for the process of introducing changes in mechanisms for combating VAT abuse at the EU level. It will also be seen whether VAT in the form we know today will survive these changes.

The battle may be won, but the war goes on: What can be done to keep the VAT gap narrowing?

Tomasz Kassel, a partner at PwC, began his presentation by stating that to eliminate the problem it is necessary to eliminate VAT itself, which the EU cannot allow at this point. Thus, the EC and specific countries are undertaking actions to tighten up the collection of VAT, which are bringing certain results. According to PwC forecasts for 2016, the VAT gap, which includes fraud and the gray zone, will narrow from 2.8 percent of GDP in 2015 to 2.5% in 2016. As causes of the narrowing of the gap, Kassel cited the introduction of the fuel regulatory package and the Single Audit File (JPK), as well as a higher number of tax audits (although, as he noted, such audits often target the wrong entities. Discussions are currently ongoing on the introduction – following Hungary’s example – of a packet of transport rules with the purpose of further combating irregularities on the fuel market. According to Kassel, this package could lead to a reduction in instances of VAT fraud.

For tax criminals, the real product is VAT, and the physical goods that the fraudsters are trading is unimportant, and often changes in reaction to the introduction of tighter rules and the actions of investigative organs. Mr. Kassel used examples to present how fraudsters move from sector to sector, from one product to another. VAT fraud in Poland today takes place on the export to Germany of integrated circuits, and parts and accessories for digital cameras. On the basis of trade statistics, PwC “registers” the products and sectors in current use by VAT fraudsters, and the results of these observations should provide guidance for tax authorities and investigative bodies.

To reduce the VAT gap, it is necessary to improve analytical operations, tighten up international cooperation within the region, and also to continue and intensify dialogue between the tax administration and business, which often has information that’s important for the authorities. A good solution would be to create specialized units to fight fraud, on the model of Italy’s Guardia di Finanza. At the moment, VAT fraudsters in Poland are dealt with by several agencies, whose work is often uncoordinated.

Investigative agencies problems in uncovering and combatting crime related to VAT fraud

Piotr Laskowski of the ABW’s Bydgoszcz Field Office described how the fight with VAT fraud looks from the practical perspective. Crime related to VAT frauds has reached tremendous proportions, is very well organized and has international reach. One of the challenges related to the scale of the fraud is the appropriate classification of crimes. Two legal acts cover this area: the Criminal Code and the Fiscal Criminal Code. The Fiscal Criminal Code calls for very mild penalties for tax fraud, as a result of which organized criminal groups set up this type of fraud. According to Mr. Laskowski, to successfully fight VAT crime, the Fiscal Criminal Code should be eliminated, or changed to take into account the social harm caused by tax crime.

Another problem is the lack of coordination between institutions investigating VAT fraud. Similarly to Mr. Kassel, Mr. Laskowski reacted positively to the appointment within the tax administration of tax police specialized in conducting preparatory proceedings concerning tax crimes. The ABW expert also proposed shifting the weight of the fight against tax fraud from procedural activities to the pre-process stage, meaning operational-reconnaissance activities.

The speakers’ presentations were followed by a lively discussion with seminar guests. The discussion touched on subjects including the structure of the VAT, the desirability of shifting to the kind of sales tax that exists in the United States as well as the difficulties related to calculating the true level of VAT fraud.