The VAT Fraud Trap

It is an unfortunate fact of life that most businesses do not become aware of the risks they are exposed to until it is too late. That is certainly the case when it comes to the risk of getting entangled in VAT fraud. Many businesses are entirely unaware of just how easy it is for VAT fraudsters to compromise the activities of legitimate trading – or just how much they could lose if that happens.

Any business can become an unwitting participant in VAT fraud. All that is needed is a traded commodity, physical or virtual. Some of the most established blue-chip companies are also the most vulnerable. While fraudsters are often small companies or individuals in obscure jurisdictions, they actively seek to cloak VAT frauds by engaging with large and reputable businesses. In recent years, VAT fraudsters have moved on from high value electronics to a wider range of sectors including food and drink, labour providers and emerging financial services. The telecoms sector, with high value intangible trade, is a particular target, although no one is immune.

‘But I’m not the fraudster,’ says the big company with a reputation to protect. Unfortunately this is no defence. Under a 2006 ruling from the European Court of Justice, known as the Kittel decision, a company can fall foul of the relevant tax authorities, even without knowing there is a fraudulent actor in the supply chain. If they merely could have known, they are at risk. This principle was reaffirmed in UK law under the 2017 Finance Act, where HMRC created an additional 30% penalty, in addition to any tax denied. The value of input tax refunds that the Revenue can withhold or penalties that can be levied often run into millions.

In the European Union the most common form of VAT fraud is usually known as Missing Trader Intra Community Fraud, or MTIC. Even though the UK is leaving the EU, the threat of Missing Trader fraud will remain (the UK government’s recent guidance is that underlying VAT arrangements will change little post Brexit, although administrative procedures will alter). In recent years Missing Trader frauds have become increasingly complex, but one thing is constant: somewhere in a supply chain a fraudster charges VAT on a trade, but fails to pay the VAT due to a national tax authority. The trader ‘disappears’ – hence the Missing Trader of the title.

Missing Trader frauds have been around as long as VAT itself. This tax is an essential part of EU revenue arrangements and the multi-jurisdictional nature of European VAT regimes has created a rich field for tax evaders. The first organised Missing Trader frauds tended to focus on high value small size goods, like mobile phones and silicon chips, but as trading in intangible goods such as data and services has grown, so has the value and complexity of VAT fraud. According to the most recent figures from the European Commission the VAT lost to fraud in 2017 was EUR 137.5 billion, over 11% of the tax due.

Post-Brexit the EU is likely to remain the UK’s largest trading partner, but VAT administration may become more complex for UK businesses selling across borders – and complexity is always the fraudster’s friend. Additionally, EU member states have traditionally taken a cooperative approach to tackling MTIC fraud, given that it often relies on taking advantage of goods and services crossing EU borders. It is therefore critical that the UK continues to share intelligence, in order to manage the fraud threat.

In this period of change we believe companies need to build their own defences and expertise. Deloitte has developed forensic techniques that identify red flags in trading patterns and build KYC processes. These techniques can help to block likely fraudsters and avoid challenges under the Kittel judgment. We know when companies are most vulnerable to MTIC infiltration, as well as how to train key staff in fraud awareness, and how to mount robust defences to challenges from revenue authorities.

Knowledge is always the best defence. Understanding the risks of this most common and pervasive fraud is now vital to protect revenue and reputation.