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S. Sridharan

S. Sridharan on the various types of VAT fraud and their implications

AS PER the draft VAT law of various States, a dealer is allowed to carry forward the unutilised 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.

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.

Export VAT 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 are used in such frauds. This fraud can be checked only on an inspection of the documents filed in proof of exports.

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 euros (an average of about 2 million euros per case). According to the tax administration of EU member-states, a point of particular concern is that 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, while 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 loss to the exchequer.

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 (August 17, 2002) will help one 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 per cent. The fraudsters pocket the VAT money and disappear. The amounts involved are enormous — £200 million and above are not uncommon. In more sophisticated versions called carousel fraud, the phones are imported VAT-free and pass through 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. Such companies are called `bashers', because they bash the VAT.

Relevance to India: India does not face the immediate prospect of facing carousel fraud, which happens because of 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 available on the VAT paid on 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 across States, similar frauds may happen.

MTIC or acquisition fraud

In missing trader intra community (MTIC) or acquisition fraud, the dealer registers under VAT, charges the VAT on his sale, but disappears without sending any return or paying the VAT due.

MTIC fraud 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.

A pre-Budget report in the UK puts the country's revenue losses due to intra-community missing trader fraud at £1.7-2.6 billion in 2000-01.

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.

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 VAT on the bogus invoices raised in his name and has to convince the officials that he had not issued those invoices.

The August 17, 2002, report in The Guardian covers cloning fraud as well: "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."

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 £24 million of VAT. To amass this amount of liability, they would have to have booked more than £135 million of sales through this company in 50 days' trading — enough to rank it as one of Britain's biggest firms."

Relevance to India: 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:

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