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Fraud: EU Committee Report

My Lords, as a member of Sub-Committee A, I join the noble Lord, Lord Steinberg, in paying tribute to the noble Baroness, Lady Cohen, for running our debates on the inquiry with a rod of iron. She is primarily responsible for the very high quality of the product. I commend the report to the House. As we worked on the inquiry we found that the subject was larger than we had first thought. Most of us concluded that, while we might have some doubts about the means of extended verification being used by HMRC to deal with the fraud we had no doubt about the necessity for strong action to deal with what was undoubtedly a substantial organised criminal attack, deliberately defrauding the Exchequer and hence honest taxpayers through manipulating the system for charging VAT on mobile phones and computer chips traded across frontiers. The sub-committee concluded that HMRC was right to claim that it was succeeding and that the scale of the fraud in respect of such goods was diminishing. We also thought the Government right to seek EU agreement to a derogation permitting reverse charging in respect of mobile phones and computer chips. That has ended the fraud in this country on these goods. We were delighted about that, although we noted that the scope of the derogation was rather shorter than the Government had wanted, more restricted and only two years rather than the three originally sought. But we became more and more uneasy—or at least I did—as the inquiry went on. Many of us felt that we had stumbled on to a larger issue. The reverse charge derogation is extremely effective but merely transfers the problem elsewhere in the European Union. So its renewal in two years’ time is by no means a foregone conclusion. Given the scale of the prize available to the criminal—we were told that the incidence of this fraud in this country reached £3 billion in 2005-06—and the enormous complexity of the defensive extended verification procedures required to combat it, it seemed to us inevitable that, with mobile phones and computer chips blocked off for the present, the fraud would migrate and mutate to something else. The Government did not dissent. They told us that the next vulnerable sectors would be iPods and satellite navigation systems. They talked then of cosmetics, pharmaceuticals, precious metals and computer software, and even, possibly, razor blades or golf clubs; that is, any sector where the traded goods crossing the frontier are high in value and low in volume. We saw little chance of the Government being able, by a series of successive reverse charges, to pass the buck. We applauded the enforcement efforts, but we thought that the criminal always would be probably a step ahead. The authorities would go on being valiant in trying to plug gaps in the dyke, but we began to wonder whether it might not be better to drain the lake, which is why the second half of our report looks at options for change to the overall EU system as it applies to cross-border trade. In my view, the Government have reacted rather encouragingly to our recommendations. In their reply, they have accepted that there is a systemic weakness in the VAT treatment of cross-border trade and have confirmed that they are actively engaged in exploring, with other EU member states, a number of options for change. We highlight a number of options in our report, but I want to touch simply on two which seem to be the most promising. The first option would be to move away from today’s destination system, whereby VAT is collected in the country where the goods are finally sold, to an origin system, whereby it is collected in the country where the goods are first produced and then distributed through a clearing-house. That would undoubtedly eliminate missing trader fraud. As the noble Baroness, Lady Cohen, said, that was indeed the system which was first proposed and which the United Kingdom hotly opposed in the early 1990s. The noble Lord, Lord Lamont, who is in his place, was eloquent in attacking this system. I worked for him at the time. I could not match his eloquence, but I attacked as his dog of war. The Commission proposed an option system, which was defeated not just by the eloquence of the noble Lord, Lord Lamont, but by the general acceptance around the council table that the clearing house system would be immensely complicated. That is why we ended up with the destination system, which is still known in Brussels as the ““provisional”” system. It was always envisaged that it would be replaced in due course by an origin system. As the French say, nothing is more permanent than the provisional. The noble Baroness, Lady Cohen, said that I should explain why I sinned so greatly. We were trying to build a single market and were getting rid of an enormous number of checks at frontiers, paperwork and documentation, and we succeeded. The 1992 programme brought about a tremendous liberalisation of intra-EU trade, but I now believe, like Lord Keynes, that when the facts change, you had better change your views. I have changed my views on an origin or destination system. The facts have changed. Modern technology now copes perfectly well with a clearing house on the scale envisaged. It seemed horrifically complex at the time. When one thinks of inter-bank clearing systems or, as the noble Baroness, Lady Cohen, said, securities trading, it is perfectly possible to envisage a clearing house system which would work. Moreover, the Commission now suggests that the VAT which would be remitted through the clearing house should not be at the rates charged in the country of destination but at a flat rate which would be the same wherever the destination. As the noble Baroness, Lady Cohen, said, it could be the EU average rate of 15 per cent or the median rate of 18 per cent. It does not matter. The clearing house would deal with only one rate, which would be a huge simplification of the systems and would greatly benefit traders. I pay tribute to the excellent evidence given to us by the Institute of Chartered Accountants. It came down firmly in favour of a solution on those lines. Government witnesses were rather more cagey and I think that I traced three streams of scepticism. First, there was scepticism about such dependence on IT, which I can understand. Secondly, I thought that I detected a feeling that it would be rash to rely on other member states to be active in the collection of VAT on goods destined for export, because the VAT so collected would be distributed through the clearing house to the country of import—that is, another country. That seemed to me to be a rather unworthy suggestion. Co-operation between national and fiscal authorities in the EU has always been rather good. The current system leaves the Revenue and the honest taxpayer at the mercy of the criminal. Given the choice, I would rather trust the tax man. The third objection we heard is based on a misunderstanding. It has been suggested that an origin system plus a clearing house might infringe national fiscal sovereignty. This is untrue. Lest noble Lords think my judgment has been coloured by seven years in Brussels, do not take my word for it; take the words of the Institute of Chartered Accountants, which is no crazy Euro-phile. Its evidence states that, "““the harmonisation of rates of tax in member states is not essential in order to operate the origin system””." The proposed system would not in any way limit our ability to set our own rates of VAT or to continue our zero-rating of particularly sensitive goods. Neither standard rates nor harmonised coverage would be required. Fiscal sovereignty would not be impugned. The difference from the present system would be that the huge rewards available to the criminal would disappear. If a move to an origin system is thought too dramatic—it certainly would take time and there would be a very high transitional cost—one could envisage a refinement of the destination system which might be equally effective in eliminating fraud. We learnt from the Commission’s evidence—I pay tribute to Commissioner Kovacs and his team for their constructive co-operation with our inquiry—that it has just such a solution on the stocks. It, too, would involve simplification. Instead of obliging the trader to register in the country to which he was exporting his goods, and to pay VAT at the rate applicable in that country, the Commission now envisages a one-stop shop where the trader would account for all his liabilities in all other member states, online, in his own language, in his country of establishment. It would not be a clearing house but a self-clearing system. This solution, too, would eliminate or massively reduce the scope for missing trader fraud. It, too, would not threaten fiscal sovereignty and would be dependent on effective IT. I am not an IT expert any more than I am a tax expert, as has already become clear in this debate, but my plea to the Minister is that he urge his new Treasury colleagues to approach both options I have described with an open mind, in a spirit of inquiry about their practicality. The key question is not whether this was something we opposed 15 years ago; it is whether it would work today and prevent fraud tomorrow. There is sometimes too much theology in these matters. Remember Alexander Pope, who said: "““For forms of government; let fools contest: Whate'er is best administered is best””." The Government deserve our support for their success in getting on top of missing trader fraud in mobile phones and computer chips. I hope that they will be just as successful, although rather more speedily, when the fraud switches to another sector, as it no doubt will. Perhaps it already has. I thank the Government for admitting that there is a systemic weakness which the criminal will always seek to exploit. So the long-term solution is a change of system. The Commission will produce its reform ideas later in the year. I hope that the Government then will come back to the House with their reactions. If they do not agree with the Commission’s proposals, I hope that they will bring forward alternative suggestions for reform.