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I have received a number of mails from the
users of stvat.com that international experience relating to VAT
should be presented.
Study of International experience in
implementation of VAT will definitely be useful to understand
the experience of different countries in handling the opposition
to VAT, containing inflationary effects of VAT immediately on
implementation, Zero rating of goods and supplies, Tax credit
for capital goods, concessions for retail and small traders,
administrative mechanism, fraud detection etc.,
In most of the countries the VAT levy is on
goods and services. Each country had adapted VAT as appropriate
to the business and political environment in each country. The
system followed in one country may not be relevant to another
country. Though I have attempted to study the practices across
the globe, say writing on "Flat Rate Scheme" or on
"Cash Accounting" in the U.K. may not be relevant in
the current Indian context.
The one area, I thought, may be of relevance
to all of us, tax administrators, trade and industry and
professionals, is the international experience in combating VAT
frauds though it may be sentimentally inappropriate to write on
VAT frauds when we are looking forward to the auspicious event
of the successful implementation of VAT.
There are instances in the U.K. where genuine
businesses have been charged with being a party to a fraud with
huge demands being slapped on them to the point that if they
fail to succeed in appeal, the businesses face imminent closure
under the impact of the demand raised by the department.
VAT frauds will also impact genuine VAT
registered business that may unknowingly be drawn into the
vortex of ingenious schemes designed by organised fraudsters. It
is therefore important for dealers also to be aware of the
possible areas where fraud can occur so that they can be
vigilant and do not unwittingly become party to an organised
fraud as in the case of a "Missing Trader Fraud" or
"Cloning Fraud".
The State Governments are currently involved
in the design of VAT Information System for registration of
dealers, processing of returns, MIS reports on potential areas
of VAT leakage etc. I thought it appropriate to write on the
important subject of Combating VAT Frauds/leakage so that they
can take care to design the software to flash warning signals of
a potential VAT leakage.
Self-Policing
Mechanism of VAT may prevent frauds is a myth
A much professed benefit claimed for VAT was
that it was ‘self-enforcing’ in a way that other indirect
taxes were not. As VAT is paid at each stage of production, in
order to claim credit for the VAT paid on its inputs against the
VAT received on its outputs, a business would need to show, if
required, that the VAT had been paid by its suppliers.
‘One man’s proof of purchases is evidence
of another man’s sales.’ There would be no incentive for two
traders to fail to invoice a transaction between them since the
purchaser’s liability for VAT would be increased by the amount
the supplier had not been recorded as paying. With an indirect
tax levied at only one stage of production the whole of the tax
is potentially at risk at that stage, whereas with VAT,
theoretically at least, it is only the tax added at that stage
that is at risk.
In the National Economic Development Office,
Value Added Tax, (2 nd ed., 1971 HMSO, London) at p. 19, It had
been recognised that there was scope for evasion even though VAT
was held to be ‘self-policing’. Tax could still be evaded by
failing to invoice final customers or tax-exempt purchasers and
there was further potential for evasion in wrongly classifying
untaxed and taxed goods. The report of the National Development
Office also recognised that these possibilities would not ‘exhaust
the ingenuity of tax evaders’.
TYPES OF VAT FRAUD
The different types of VAT frauds
encountered internationally may be categorised as follows:
1.
Suppression of Output:
This is a deliberate act of the VAT
registered dealer to record all his sales. This is more
prevalent in those trades where cash payment is common.
2.
Under valuation of Output:
Undervaluation is the most infamous way of
evasion. Here the unit declares a lower price than the actual
price. This may again be done in two ways. Usually the
taxpayer gets into understanding with the receiver of goods
and a lower price is declared in the documents. The taxpayer
may decide to totally ignore his counterpart if he is daring
enough to forge documents and replace the genuine ones.
3.
Misdeclaration of Quantity
Misdeclaration of
quantity is resorted to whenever there is little scope of under
valuation and where counting or measurement of quantity is a
prohibitively problematic task. The advantage is that (i) there
is little scope of detection from documentary audit or scrutiny
and so, (ii) once the consignment is cleared out there is
virtually no way to establish that an evasion had been effected.
Misdeclaration of quantity is a favourite form of evasion.
Miscalculation may also take place. Straightforward error of
calculation either in calculating the assessable value or the
tax liability may be restored to by the taxpayer. Another way to
evade tax liability may through forging of payment receipts for
clearance.
Frauds under 1 to 3
above can be checked by framing proper rules regulating the
Input Tax Credit that can be carried forward from one accounting
year to the next. Under the draft VAT law of various States the
dealer is allowed to carry forward the unavailed input tax
credit in one tax period to the next. By suppression of Output
tax payable by under invoicing, the input tax remaining
unadjusted will remain inflated. At the end of the year the
dealer will have an inflated input tax credit disproportionate
to the input tax actually paid on the goods remaining in stock.
The dealer may be required to file a yearly declaration of stock
with details of input tax paid thereon and the input tax credit
eligible for carry over to the next year may be restricted to
the input tax actually paid on goods in stock.
4. Inflation of Input Tax Credit:
This is the device by
which the dealer inflates the input tax credit through the use
of false invoice to show non-existent or overvalued purchases.
Though filing of a
stock declaration at the end of the year may partly check this
type of fraud, the use of false invoice can be checked as
discussed under "Missing Trader Fraud".
5. Export VAT
Fraud or Export Diversion fraud:
The dealer applies
zero rate for non existent or overvalued exports and claims
refund but diverts the covered goods to home use. Basic consumer
and luxury goods have been involved in such frauds.
This fraud can be
checked only on an inspection of the documents filed in proof of
exports.
6.
Carousel fraud:
Essentially this fraud involves abuse of
the exemption mechanism of the VAT system. It is reported that
during the first half of 1998 EU Member States detected around
250 cases of such fraud (called carousel or IC-acquisition
fraud) involving a revenue loss of around €500 million (an
average of about €2 million per case). A point of particular
concern is that, according to the tax administrations of EU
Member States, the amount of tax defrauded in individual cases
is growing.
Carousel fraud is the carrying out of
repeated (cross border) purchase and sales transactions within
a rapidly changing group of companies. The cross-border
dimension means that VAT is not paid in the country of origin
but the company in the country of destination disappears
without payment of VAT. Usually an extensive and complicated
chain of transactions in several countries is used to cover up
what is actually happening. Carousel fraud is often
perpetrated by criminal organisations and involves
considerable losses to exchequers.
Carousel fraud involves the continuous
movement of goods between co-operating traders in different EU
member states, resulting in multiple tax losses.
The fraudsters often insert a series of
companies into the supply chain to make detection difficult.
Goods that are easily traded and have a high value and low
transport costs, such as computer components and mobile
phones, are particularly attractive to Missing Trader
fraudsters. The goods themselves may remain in one place, but
financial transactions give the appearance of numerous
business purchases and sales.
A recent case reported in the
"Guardian" (17th August, 2002) will help
understand the modus operandi:
"The swindle relies on the European
single market. No VAT is charged for trading between EU
countries, and mobile phones are ideal for trafficking because
they are in high demand, and easy to transport.
Fraudsters use a front company to import
the phones VAT free within the EU and then sell them on to
other traders in the UK charging VAT at 17.5%. The fraudsters
pocket the VAT money and disappear. The amounts involved are
enormous: £200m is not uncommon. In more sophisticated
versions called carousel fraud, the phones are imported, VAT
free, and pass through the hands of a number of companies.
Somewhere in the chain there will be a
trader who disappears with the VAT money. Eventually, the
goods are exported back out of the UK. Then they return, to go
round again with a new missing trader. In some cases the
mobile phones never move out of the warehouse. Only the
paperwork shows movement. One criminal approached by Stoke
fraudsters says: "They're called Basher companies -
because they bash the VAT. Everyone's moving into it".
Relevance in
Indian Context
India does not face the immediate prospect
of facing Carousel fraud which happens due to the system of
charging the VAT on Inter EU sale between different countries.
Under the system in vogue, in the case of trade between two
VAT registered dealers in different countries, the sale is
zero rated in the exporting State and the VAT tax is paid by
the importing dealer at the point of purchase. Input Tax
Credit can be availed of the VAT paid on the imported goods
when the goods are subsequently sold. In the case of export by
a VAT registered dealer to a non-registered dealer, the
exporting dealer bills the VAT.
In India, there is a strong lobby, which
calls for making Inter State Sale Zero-rated. If that happens
without a proper mechanism to track and monitor Inter State
sale we may have to face similar frauds.
7.
Missing Trader Intra Community fraud (MTIC) or Acquisition
fraud :
The dealer registers under the VAT, charges
the VAT on his sale but disappears without sending any return
or paying the VAT due.
Missing Trader Intra Community fraud
(MTIC)
exploits weaknesses in the intra EU VAT system and is
prevalent in all EU member states. It appears to have started
to escalate in the UK around 1998. The fraud involves
obtaining VAT registration for the purpose of purchasing goods
from a VAT-free source elsewhere in the EU, selling the goods
at a VAT-inclusive purchase price, and going missing without
paying the VAT. This is commonly known as acquisition fraud,
and often involves items with rapid turnovers that are moved
in high volumes, such as soft drinks and confectionery.
The pre budget report in the UK explains
this fraud as follows:
In 2000/2001 UK revenue losses due to
intra-Community missing trader fraud amounted to between £1.7
billion and £2.6 billion.
VAT Intra-Community Missing Trader Fraud is
a systematic criminal attack on the VAT system, which has been
detected in many EU Member States. In essence, fraudsters
obtain VAT registration to acquire goods VAT free from other
Member States. They then sell on the goods at VAT inclusive
prices and disappear without paying the VAT paid by their
customers to the tax authorities. The fraud is usually carried
out very quickly, with the fraudsters disappearing by the time
the tax authorities follow up the registration with their
regular assurance activities.
8.
Cloning Fraud
This is a fraud
perpetuated by using the VAT Registration numbers of reputable
companies. The modus operandi is that a person carries on
business without registering himself but by using the VAT
registration number of someone else. The dealer disappears
without filing VAT returns as he obviously cannot file using the
hijacked VAT registration number. The innocent buyer of goods
from this dealer who claims Input Tax Credit on the purchases
effected faces the prospect of his claim being disallowed at a
later date when the officials discover that the invoice is
bogus. The dealer whose number has been hijacked also has to
face the demand for payment of the VAT on the bogus invoices
raised in his name and has to convince the officials that he had
not issued those invoices.
The report in the
Guardian dated 17th August 2002 covers Cloning fraud
as well.
'Cloning'
"Others have developed a new method,
hijacking, or "cloning" the VAT registration numbers
of reputable companies. The innocent business with its VAT
registration details hijacked knows nothing about it. But when
the missing trader disappears with the VAT, the legitimate
trader may find himself picking up the bill.
One trader, who wishes to remain anonymous,
is attempting to claw back over £700,000 of VAT that customs
are refusing to pay him after they discovered that the company
he was buying from was using a cloned VAT registration number
and had disappeared.
The businessman, who is taking customs to a
VAT tribunal, faces ruin. "I have to appeal. But there's
still a chance you lose. And if you lose, you're out of
business."
Mr Mavin says: "Customs should
concentrate on preventing fraudsters from registering for VAT,
rather than going after innocent traders for the losses."
But a customs representative told the
Guardian: "If somebody has been negligent themselves in
not carrying out the checks or making sure they are not part
of a fraud, then appropriate action is taken. Companies have
to take responsibility for their own actions."
In addition, customs are using the civil
courts to reclaim extraordinary amounts of missing VAT.
Last month, customs issued a civil writ
against Stoke-on-Trent-based Stephen Hancock and Barbara
Moran's off the shelf company Worldsoft Ltd, demanding a
return of nearly £24m of VAT. To amass this amount of
liability, they would have to have booked more than £135m of
sales through this company in 50 days' trading - enough to
rank it as one of Britain's biggest firms."
Relevance
in Indian Context
The case of Missing
Trader or Cloning also happens in a single point system of levy.
Tax administrators in India will be familiar with "Bill
Trading" whereby exemption is claimed as second sales based
on an invoice with non-existent or bogus RC number.
The VAT information
system should have a proper mechanism to monitor new
registrations particularly with greater attention to the
following:
1.
By experience the officials will know the problem areas
and commodities. New registration for business in the
designated areas and in the designated commodities must be
flagged as "Risk activity" for monitoring even at
the time of registration.
2. Fraudulent persons will immediately come to know of the
commodities being monitored and will avoid registering as
dealers in the commodities being monitored. The tendency
will therefore to register as dealers in some other
commodity. The VAT information system should alert when the
commodity reported in the monthly returns are different from
the commodities declared at the time of registration.
3. The system should also cross check the commodities on
which input tax credit is claimed by all dealers with the
corresponding return of the selling dealers for the
commodities sold.
4. The software must also provide for cross checking of
output tax declared by dealers with the input tax credit
claimed by other dealers as purchases from a particular
dealer.
5.
The software should have a proper alert mechanism in the
VAT information system to track stop filers, new registrants
declaring abnormally high sales in the initial months of
registration.
6. From experience the officials will know that a particular
type of fraud perpetuated is generally confined to a local
area or a particular commodity. It may be noticed from
experience that a fraud like, say, "Bill Trading"
is replicated in a particular locality by more traders when
they see another dealer successfully operating a "Bill
Trading" network. Applications for new registration
from particular areas or for particular commodities that
have been identified should be carefully scrutinised.
7. The system should facilitate access to the dealers to
verify their tax credit status and the proper recording of
their returns, if not filed online by the dealers. The
dealers should also have access to the list of dealers who
have claimed input tax credit based on sales of the dealer
so that "cloning" fraud may be detected by the
dealer himself.
8. The software should be designed to analyse trends in tax
credit and output tax declared commodity wise and should
automatically alert in the case of a abnormal rise or fall
in the tax credit availed/ output tax payments in any
specific commodity.
9. The officials should watch out for offer of sale of goods
at prices much cheaper that the prevailing market prices.
Frauds have happened in the case of popular and fast moving
goods. The fraudsters charge VAT in the bills and offer a
VAT inclusive cheaper price with the intention of not paying
VAT.
A recent instance is a warning by a reputed
tyre company Michelin who had warned customers and
distributors to be wary when offered truck tyres at
extraordinarily low prices. Michelin is working with police
and customs authorities in Europe as it appears that these low
prices can only be the result of illegal activities believed
to be VAT fraud.
10. More importantly it should be remembered that frauds
cannot be perpetuated for long without the knowledge of some
of the officials who are either ignorant of the provisions
of law or for reasons best known to them choose to ignore
certain happenings. So officials need to be trained on all
aspect of detecting mistakes/malpractice/frauds early and be
aware of the consequences to themselves and to the
businesses solely of their failure to deter wrongdoings.
11. As part of the good governance initiative, the department
may consider constituting a "Audit Committee" of
experienced officials and experts drawn from outside the
department to review the software and the MIS reports. The
advantage of having outside experts with domain knowledge
and experience in audit is that being an outsider not
involved in the day to day routine of the department they
will be able to analyse the data objectively.
This list is indicative and is not
exhaustive. I am sure the department would have considered a lot
more factors than what is listed here.
The department must take enough care in
registering a dealer under VAT rather than penalising a genuine
dealer at a later date.
Trade and Industry should carefully study
the penal provisions in the draft VAT Act to ensure that there
are no provisions penalising a genuine dealer for the inability
or the delay on the part of the department in tracing a
fraudster.
9.
Repayment Fraud:
This is a device whereby someone registers
a totally false VAT business with the aim of submitting false
repayment returns.
Repayment fraud comprises the recovery of
VAT on wholly fictitious or exaggerated transactions by a
bogus business.
10.
Multi cell repayment fraud:
This is a sophisticated version of the
repayment fraud where someone sets up multiple bogus
registration, each of which reclaims small amounts of VAT.
Repayment frauds can be detected only on
personal inspection of newly registered businesses and
periodical survey.
11.
Misdescription of the VAT liability:
This occurs when supplies are recorded as
zero-rated or subject to tax at a rate lower than that
applicable to the relevant goods.
This can be detected by scrutiny of the
returns filed. Wrong application of rate of tax may be also a
genuine mistake on the part of the dealer. In the absence of a
scrutiny of returns filed for every tax period, wrong
application of rate of tax will be detected only at the time
of final assessment and this will affect all dealers upstream
and downstream in the supply chain. To have accountability on
the part of the officials and to safeguard a genuine mistake
in the application of the rate of tax, there should be a
provision in the VAT Acts that no demand can be raised beyond
six months from the date of filing of returns.
12.
Contrived Insolvency and Fraudulent Liquidation:
Under this huge VAT liability is built up
and the business is fraudulently liquidated.
Only seasoned and organised fraudsters will
attempt this type of fraud. Stop filers need to be closely
monitored to detect the fraud early.
13.
Unregistered evader fraud:
This involves genuine
traders who have turnovers above the VAT threshold but fail to
register for VAT. These categories of tax evasion are usually
concentrated in cash-based businesses.
TYPES OF VAT AVOIDANCE
SCHEMES
The different types of VAT avoidance schemes
encountered internationally may be categorised as follows:
1.
Disintegration:
This involves artificial fragmentation of
business into smaller units to keep the turnover below the
threshold limit and avoid registration under the VAT.
This may happen in India probably only in the
case of retail traders.
2.
Partial Exemption:
Partial input tax
credit is required to be calculated when tax paid inputs are
either used in the manufacture partly of tax paid goods and
partly exempt goods or when the goods purchased are sold partly
to taxable entities and partly to exempt entities.
By exploiting the rules which apply to partly
exempt supplies, traders recover substantially more tax than was
intended.
This can be plugged by providing for
practical rules of apportionment of input tax credit between
taxable and exempt sales.
PRE
BUDGET REPORT OF
UK CUSTOMS AND EXCISE ON TACKLING VAT LOSSES
The 2002 pre budget report of UK Customs and
Excise published on 27th November, 2002 highlights
measures on tackling VAT losses and is very relevant in the
Indian Context also. These losses - caused by fraud, avoidance,
non-compliance and the failure of businesses to register for VAT
- measured as the proportion of the VAT that should be collected
- rose fastest in the early 1990s, but have stabilised over the
past six years at 12 to 14.5 per cent.
Extracts from the report:
Tackling VAT losses
"Protecting indirect tax revenues also
sets out the first ever concerted strategy to tackle the VAT
revenue losses, which have a wide variety of causes from
deliberate fraud and avoidance to simple error, which have
been a standing feature of the VAT system for more than a
decade.
Supported by the deployment of 1,000 staff
to key problem areas, Customs will expand the support they
give to help businesses meet their VAT liabilities, while
cracking down hard on those who choose not to comply, who
engage in abusive tax avoidance schemes, or who try to defraud
the revenue.
This strategy is designed to reduce the
proportion of VAT which goes uncollected, and produce more
than £2 billion per year in additional VAT revenues by
2005-06 which – instead of being lost – will go to support
increased investment and improvement in the public services.
This is the Government's aim, but in line with the audited
approach underlying public finances, it is incorporating a
lower figure in the Pre-Budget Report public finance forecast.
"
The VAT strategy
Summary of the VAT strategy
The key measures, which will deliver the
VAT strategy, are as follows:
-
The deployment of 1,000 staff both to enhance existing
efforts in the key problem areas and provide the resources
for the new activities described below;
-
A new out-reach programme designed to get businesses,
especially newly-registered ones, into a sustained pattern
of voluntary compliance;
-
A broader-based, intelligence-led, risk-based approach
to tackling non-compliance, based on improved analysis of
the patterns of non-compliance, and targeting of resources
on high-risk sectors of the economy;
-
An increase in the use of deposits and guarantees to
secure timely VAT payments from businesses with histories
of persistent non-compliance;
-
A one-off, short-term scheme where unregistered
businesses operating above the VAT threshold will be able
to obtain relief on their penalties if they come forward
for registration voluntarily;
-
followed by a tough crackdown – alongside Inland
Revenue – on those businesses who continue operating
above the registration threshold but outside the VAT
system;
-
The recruitment of a number of new highly-specialised
anti-avoidance experts with proven ability to identify and
shut down legislative loopholes and abusive tax avoidance
schemes;
-
The inclusion – alongside the Regulatory Impact
Assessments which accompany new legislation – of a
specific avoidance impact assessment, explaining the
elements included to prevent avoidance and the steps taken
to make the legislation avoidance-proof;
-
A substantial increase both in the speed with which
avoidance schemes are identified, and in the number of
schemes challenged;
-
A stepping up of efforts to prevent bogus traders from
registering, identify those already on the register, stop
their frauds before they grow, and recover VAT Missing
Trader debts from the fraudsters; and
-
The use of Customs’ specialist investigators, with
proven track records in dismantling organised criminal
operations, to target the gangs behind Missing Trader
Fraud.
The purpose of this article is not to cause
alarm but to draw attention to international experience in
tackling VAT leakage and evasion.
01/12/2002
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