Protecting against VAT fraud

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  • 2017 Number 01

    IntroductionThe European Commission estimates that VAT carousel fraud costs the EU economy in the region of 50bn in lost revenue per annum. Little wonder, therefore, that the issue of VAT carousel fraud is high on the agenda of the EUs tax authorities and law enforcement organisations.

    But is the risk of VAT carousel fraud high on the agenda of Irish businesses? The answer to that is probably not in most cases. However, legitimate businesses that have no intent to engage in or benefit from fraud cannot be complacent to the risks. Revenue

    and other tax authorities have powers to target not only fraudulent traders but also other businesses that knew or should have known that they were involved in fraudulent transactions.

    The consequences of being caught up in a fraudulent transaction are potentially signifi cant and include disallowed input VAT on purchases, VAT liabilities on cross-border sales, and being held jointly and severally liable for VAT due by the fraudulent trader.

    This is a live issue. We are aware of a number of cases where traders who inadvertently

    David Duff yVAT Director, KPMGSuzanne ODonovanVAT Manager, KPMG

    Protecting Against VAT Fraud


  • Protecting Against VAT Fraud

    became part of a fraudulent supply chain are under investigation. To protect themselves, businesses must take steps to obtain suffi cient information in respect of their trading partners and watch out for risk indicators. As Revenues guidelines on how to protect your business from VAT fraud (eBrief No. 82/2016) state: if a commercial proposition looks too good to be true it probably is.

    This article considers the Irish and EU VAT principles under which legitimate traders can be held liable for unwittingly being a party to transactions involving VAT fraud. We also discuss what legitimate businesses can do to protect themselves against these risks. Lastly, we consider potentially signifi cant future changes to the EU VAT regime with a view to reducing carousel fraud.

    What Is VAT Carousel Fraud?Any situation where a trader knowingly and deliberately underpays VAT to a tax authority can be described as VAT fraud. However, this article principally focuses on what is frequently referred to as missing trader intra-Community fraud or carousel fraud. These types of fraud are perpetrated through a circular chain of transactions, typically involving high-value, mobile and resellable goods such as consumer electronics. However, they could in principle involve goods or services from any sector, and therefore the risk of fraud exists across all industries.

    The fraudsters manipulate the cross-border and domestic VAT rules to create a situation where they can purchase goods without payment of VAT and sell them on with VAT to innocent

    Fig. 1: Simple example of how an innocent trader could be caught by VAT carousel fraud

    1. UK trader sells goods to Irish-VAT-registeredfraudster (X) for 1m

    with 0% VAT

    2. X sells goods tolegitimate trader (Y) for

    1.1m plus 23% VAT

    3. X defaults on paymentof 23% VAT to Irish


    3. Y sells the goods to UK-VAT-registered

    trader (Z) (facilitated by Xin many cases).

    4. Y applies to reclaim 23%VAT on purchase and

    applies 0% VAT on sale ofgoods to Z

    5. Fraud is discovered, and Y is at risk of being denied

    23% input credit on purchasefrom X and/or being liable for

    23% VAT on sale to Z


  • 2017 Number 01

    traders. However, the fraudster then goes missing without paying the VAT due to the tax authorities. Fraudsters are keen to involve innocent traders in the transaction chain to fund the missing VAT and to give the initial impression that the arrangements are genuine.

    The supply chains involved in carousel fraud are usually highly sophisticated to avoid detection by the tax authorities and legitimate traders. Fig. 1 is a simple illustration of how an innocent Irish distribution company could become liable for substantial VAT amounts due to its inadvertent participation in a fraudulent supply chain.

    Revenues PowersThe judgments of the Court of Justice of the European Union (CJEU) and Irish VAT law support Revenues powers to make a legitimate business, in certain circumstances, liable for the costs of VAT fraud. In the Kittel case1 the CJEU confi rmed that a taxable person can be denied the right to deduct input VAT on a purchase where it was part of a fraudulent supply chain and the taxable person knew or should have known that to be the case.

    The judgment in the case of Mecsek-Gabona2 confi rmed Member States right to refuse VAT zero rating of an intra-Community supply of goods where it has been established:

    that the vendor has failed to fulfi l its obligations as regards evidence, or that it knew or should have known that the transaction which it carried out was part of a tax fraud committed by the purchaser, and that it had not taken every reasonable step within its power to prevent its own participation in that fraud.

    Irish Revenue has in recent years taken a number of legislative steps to protect the Irish

    Exchequer, by targeting both the fraudsters and the parties they do business with.

    Finance Act 2014 introduced s108C of the Value-Added Tax Consolidation Act 2010 (VATCA 2010), under which any trader who is involved in a series of taxable supplies and who knew or was reckless as to whether or not the supply was connected to the fraudulent evasion of VAT shall be held jointly and severally liable for the payment of such VAT.3

    Finance Act 2015 introduced s108D of VATCA 2010. This section provides that Revenue can notify other parties and publish details of the cancellation of VAT numbers in Iris Oifi giil and other publications. This is intended to inform other parties that they can no longer rely on the cancelled VAT number for the purposes of their supplies to and from the entity whose number has been cancelled.

    In addition to the above, the VAT reverse-charge mechanism has been applied to domestic business-to-business supplies of particular goods and services, which are known to be at higher risk of being used in VAT fraud. These include transactions involving scrap metal and carbon emission credits. Applying the reverse-charge principle helps to reduce the scenarios where a supplier charges VAT to a customer and then potentially fails to pay that VAT to Revenue.

    Protecting Legitimate BusinessesHow can legitimate businesses protect themselves from unwittingly becoming a party to VAT fraud and being held liable under the principles set out above? Revenues guidelines in eBrief No. 82/2016 outline details of the steps that businesses should take and the high-risk indicators that VAT fraud could be involved. In our experience, Revenue looks for evidence of these steps having been taken when investigating legitimate businesses that have

    1 Joined cases C-439/04 and C-440/04.

    2 C-273/11 at para. 55.

    3 For a more detailed analysis of s108C VATCA 2010 and its interaction with EU law principles, see Frank Mitchells article VAT Fraud and Why Finance Act 2014 Has Reduced Revenues Powers, Irish Tax Review, 27/4 (2014).


  • Protecting Against VAT Fraud

    inadvertently become a party to fraudulent transactions.

    The Revenue guidelines in respect of the due diligence to be carried out when entering a transaction can be summarised as follows:

    Know and obtain independent evidence of your trading partners, including obtaining certifi cates of incorporation, trade references, credit and background checks, signed letters of introduction etc.

    Obtain and verify the other partys VAT registration details on the Europa VIES website.

    Some of the steps outlined in the guidelines, it could be argued, go beyond what would usually be expected in the normal course of business. However, the more robust the steps taken, the stronger the legitimate businesss arguments that it did not know of, should not have known of and was not reckless as to any risk of being involved in VAT fraud and therefore that it should not be held liable for the fraud.

    In relation to risk factors, businesses should be alert to anything that deviates from normal commercial practices. This will depend on the particular industry, but examples that could alert businesses that VAT fraud may be at play include:

    Limited information is available on the background of the other party, and there is a reluctance on its part to provide independent information.

    The terms of the transaction appear unusual or too good to be true, including that there is purportedly no commercial risk for you, there is a lack of formal documentation or the deal appears to be signifi cantly better than is available through other established operators.

    There is a link (either apparent or through further investigation) between the supplier and other parties in the chain. For example, does the supplier introduce you to customers for the goods?

    One or more of the above indicators does not necessarily confi rm that fraud is involved, but businesses should remain vigilant and seek answers in respect of any suspicious or unusual features of a transaction. It is important to remember that steps will have been taken to conceal the potential risk factors and to give the impression of genuine transactions.

    As VAT fraud arises on day-to-day transactions, the implementation of these steps should not be a matter only for the tax or fi nance department. A coordinated approach between functions, including procurement, accounts receivable, accounts payable and relationship managers, is needed. In addition, training for all relevant employees and a clear policy on how to identify and raise the potential issue of VAT fraud