---

Fraud: EU Committee Report

rose to move, That this House takes note of the report of the European Union Committee on Stopping the Carousel: Missing Trader Fraud in the European Union (20th Report,HL Paper 101). The noble Baroness said: My Lords, I rise to tell the House how to construct a multi-million pound fraud. This has been made possible by a European Union-wide agreement concluded in 1992, knownas the Edinburgh agreement. We, enforcement authorities and indeed fraudsters were all initially slow to grasp the full range of its possibilities but, in 1999-2000, this fraud cost the taxpayer somewhere between £1.5 billion and £2.4 billion. Between 2005-06 it rose to somewhere between £3.5 billion and £4.75 billion, an amount which would go a long way towards funding the budget for the 2012 Olympics. This has been a difficult subject on which to get a grip. The inquiry for this report started under my distinguished predecessor, the noble Lord, Lord Radice, in July 2006. However, like Her Majesty’s Revenue and Customs, we have been chasing a moving target. The original purpose of the report was to look at ways where countries could co-operate more closely in sharing information, but that issue turned out to be only a small part of the problem. When I took over the chairmanship of Sub-Committee A, we considered setting up a shell company to see if we could indeed readily commit this fraud. In the end, wiser counsel prevailed, and we decided to rely on the guidance of our special adviser, Tony Jackson from the Chartered Institute of Taxation, to whom our grateful thanks are due; HMRC, which went well beyond the call of duty, appearing several times before the committee and providing us with useful papers; and witnesses, including many small UK firms that took the trouble to write to us. I must also thank my Clerk, Simon Blackburn, and Petros Fassoulas, the committee adviser, both of whom have been indefatigable in their efforts. In describing this fraud and how it is committed, I need to remind the House that a major feature of VAT is that companies and firms collect the tax—currently at 17.5 per cent—on behalf of the Government. Companies and firms to whom a VAT rebate is due have the legal right to claim that rebate from the Government irrespective of whether the first company or firm has actually remitted the VAT it has collected to the Government. It is the Government’s problem to make sure that VAT collected on their behalf is gathered in to the Treasury coffers. Therein lies the opportunity for fraudsters and the problem for Government. Before 1992, where company A, resident in the UK, bought goods from a company in France or anywhere else outside the UK, company A had to pay VAT at the point those goods entered the country. Safe transmission of 17.5 per cent of the order value into the Treasury was ensured at that point. Company A, having received the goods in the UK, would then sell them on to company B, which would be entitled to make a claim for VAT. With the money from the first transaction safe in its coffers, HMRC would pay company B’s legitimate claims. Compare and contrast the situation after 1992 when EU countries agreed that, in the interests of fostering trade, VAT should not be payable when a company in one EU country bought goods from a company that was also in the EU. Company A, still resident in the UK, can now buy goods from a company in France without paying VAT. When said company A sells on to company B, A will charge VAT at 17.5 per cent and should then remit the money to HMRC since it is collecting the VAT on behalf of the Government. Company B remains entitled to claim back the VAT it has paid—at which point, while company A still has the money it has collected as VAT and company B has a claim for that money, company A disappears, leaving the Government facing a claim from company B, with no money from company A with which to pay it. This is why it is sometimes called missing trader fraud. I am deliberately making this simpler than it is. It is important to understand that this fraud usually involves an elaborate chain of traders and often comes round in a circle between the same fraudulent traders several times, hence ““carousel fraud””, which is the other name for the fraud. Some traders in the chain may not be involved in the fraud at all but be smaller traders who were offered goods at what seemed to them like a good price. There are many variations on the basic theme, but what they have in common is that they are designed with the objective of creating confusion and concealing the fraud from HMRC’s view. What they also have in common is a trader who has collected large amounts of VAT on the Government’s behalf and then vanished. They are very large amounts of VAT, rising to between £3.5 billion and £4.75 billion for 2005-06. The figures for 2006-07 are not yet available, so we must rely on HMRC’s contention that it is being successful in combating this fraud to some degree, but at a very substantial cost in effort, manpower and painful consequences for smaller traders. This fraud is enabled by a systemic weakness in the Community cross-border trade. Witnesses told us that this problem of the system being vulnerable to fraud was well understood in 1992, but that it was perceived that there was no alternative if trade within the European Union was to develop as all hoped. The noble Lord, Lord Kerr of Kinlochard, my colleague on the committee who was there at the time leading the negotiations for the UK, will tell your Lordships more this evening about the considerations actuating the contracting parties 15 years ago, I hope. Her Majesty’s Revenue and Customs has not, of course, sat idle while these vast sums have been stolen, but they are operating under handicap. One party can import goods free of VAT and, before vanishing, can sell them on immediately to another party who can claim the full amount from HMRC. The situation is, as one witness said, like standing in front of a jeweller’s window in which there is no glass, trying to prevent passers-by helping themselves. In these circumstances, HMRC has fought back by various means, principally by introducing a system of extended verification which subjects all claims for VAT to a process of examination and scrutiny to ensure that all the VAT due in respect of any transaction has been paid. It has also co-operated with the Metropolitan Police and the Serious Organised Crime Agency, and to date has brought two successful prosecutions against fraudsters, with others pending. HMRC is clear that it is dealing with professional criminal gangs that are also involved in other criminal activity, including money-laundering and smuggling, but have turned their attention to this fraud because of the substantial money involved. While HMRC has reduced the level of money lost to the Exchequer, it is taking the full attention of 1,550 HMRC employees, and has gone a long way to paralysing trade in the communities most affected. In evidence, we heard of companies that had been waiting 12 months for a VAT repayment, and of some that had been forced out of business by the effect on cash flow of being unable to access VAT repayments. HMRC also sought to promote more sharing of data and information between member states, but this is an elaborate process and the UK is to some extent handicapped by the requirements of the Data Protection Act from playing a full part, or persuading others to do so. In the EU, 27 law enforcement agencies need to be fully involved to make the system effective, and this is very difficult to achieve. We concluded, in the light of all this, that while the amounts being lost were being reduced, the effort being deployed was unsustainable in other than the very short term. However, at the time we took evidence, HMRC was in the process of negotiating a change in European Union rules which was finally achieved on 1 June this year. It hoped that this would prove a more permanent and less strenuous solution. This was to allow the United Kingdom to impose a ““reverse charge”” to tax on two classes of goods—mobile phones and computer chips—in which fraud and attempted fraud had been particularly rife. The reverse charge is not dissimilar to a sales tax. From 1 June, a company wishing to deal in mobile phones or computer chips cannot import VAT-free, but must charge itself VAT on the invoice so that HMRC collects the tax due as the goods enter the UK. Missing trader fraud involving these two commodities is no longer possible, and we were told that HMRC believed that the imminence of this change accounted in part for the sharp fall in fraud involving mobile phones or computer chips earlier in the year. The United Kingdom secured the derogation that enables HMRC to impose a reverse charge for only two years. More seriously, witnesses told us that the fraud, being as profitable and as straightforward as it is, will migrate to other goods and, worryingly, services both in the UK, which was of course the primary focus of this report, and in other European countries. The inescapable conclusion was that extended verification was an effective if blunt instrument that could not be deployed at its present intensity other than in the short term, and that the imposition of a reverse charge on mobile phones and computer chips was also only a short-term measure that would last as long as it took fraudsters to shift their operations to other goods and services. We therefore turned our attention to looking for a longer term solution. It seemed to us that we needed to shore up the weaknesses in the current VAT system. VAT is a useful and robust tax that is deployed by almost all developed countries, with the exception of the United States, and there is no good case for recommending a change to another sort of tax. Modifying the reverse charge system and practising it selectively in the UK could easily lead to a reverse charge being levied on several different goods—or even on all goods and services, as Austria currently proposes. The member states of the European Union would then have in effect a sales tax. This tax is markedly less robust than VAT because, unlike VAT, it all has to be collected on the final transaction rather than at different points in the chain, which renders VAT as we know it both fairer and easier to collect. Moving to a sales tax would be a retrograde step, and we would not recommend it. In essence, we recommended that the UK should seek to lead the debate on a new system for cross-border VAT payments, and we suggested some options. Work is of course being done in the Commission, and the UK is not the only member state suffering serious losses to fraud as a result of the current system, but we want the Treasury and Customs to do some new thinking and to publish a review of the options, including the ones that we have identified. Specifically, we concluded that the most promising options involved some form of an origin system. Under such a system, VAT would be charged at the rate of the exporting country, and the purchaser would be able to claim a refund of the VAT paid in his own country. Our old friend, company A, would order goods from a supplier in Luxembourg, but would have to pay VAT at 15 per cent because that is the rate charged in Luxembourg. Company A could then charge company B VAT at 17.5 per cent as he sold the goods on. HMRC would have to collect the VAT from the Luxembourg Treasury, which would require the creation of a clearing house to facilitate VAT transfers between revenue authorities. It may not surprise your Lordships to know that Treasury witnesses did not favour a change to an origin system, adducing the concern that there could be difficulties in ensuring that member states received the tax that they were due through the clearing house. They told us that around £40 billion of VAT was associated with goods traded between the UK and the other member states, and said that they believed that the system would carry considerable risk. We found this a little difficult to accept, given that substantially larger sums are allocated without incident or problem by clearing and settlement systems associated with securities trading. The Treasury also suggested, uncharitably in our view, that revenue authorities in other member states would not be motivated to collect tax revenue that they would pass to another member state. We concluded that the most promising change might be to a variant called the flat-rate origin system, which would involve all cross-border transactions carrying a 15 per cent flat-rate tax, wherever they originated, with a clearing house used to make sure that tax was received in the country of consumption. There are objections to this system, but it has the merit of being simple for both importers and exporters. It would involve setting up a clearing house, but this is no longer rocket science; the technology is now well understood and very efficient. Above all, it would not involve, as the present system does, a standing invitation to professional criminals to help themselves. I beg to move. Moved, That this House takes note of the report of the European Union Committee on Stopping the Carousel: Missing Trader Fraud in the European Union (20th Report, HL Paper 101).