EU proposes major overhaul of cross-border VAT regime

The EU is to publish proposals on reform of its cross-border VAT regime on Wednesday in what it hopes will spell the end for the “carousel fraud” that costs the union an estimated €50 billion a year.

It is the first overhaul of the regime in 25 years.

Cross-border VAT fraud could be reduced by 80 per cent for businesses under the proposed system which, the European Commission claims, should also shrink the “VAT gap”, the difference between VAT revenues expected by government and those actually collected – in 2013 some €168 billion.

Almost €1 trillion in VAT was collected in the EU in 2014 – equivalent to 7 per cent of the EU’s total GDP. But, despite the internal market, the system and rates remain fragmented and very far from borderless.

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The carousel fraudsters exploit the fact that within the EU, goods being moved cross-border between member-states are free from VAT, with the tax only due when the goods reach purchasers.

Phases

The proposed change, the introduction of the so-called “destination principle”, and which will be introduced in phases until 2022, will see exporting companies levy VAT on cross-border sales at the point of sale – ie at home – at rates determined by the VAT rates in the destination country.

Those exporting to five different states will potentially levy the tax at five different rates.

The money collected by the exporters and passed on to their national tax authorities will then be handed over to the tax authorities in the destination country.

The purpose is to create a robust single European VAT area where cross-border transactions are treated in the same way as domestic transactions (ie: cross-border trade will no longer be exempt from VAT), putting an end to the inbuilt weaknesses of the system, notably the opportunities for intermediaries in the supply chain to claim back VAT they have never paid.

The proposals require the unanimous support of member states but commission officials remain confident that the advantages in ending the substantial erosion of the tax base will make a powerful argument for that support.

In the period of transition the commission is proposing to ease in the changes by creating a “trusted trader” white list scheme under which companies with an impeccable tax record would be allowed to continue to export goods without VAT paid on them and to have it paid on arrival, as today. Such trusted trader schemes already operate in the customs area.

In recent years, VAT carousel fraud has rapidly moved from one sector to the other with criminals, often linked to terrorism or drugs, quickly adapting to action by enforcement bodies. Goods high in value, generating huge amounts of VAT in the least amount of transactions have the most appeal to them.

VAT fraud tends to move from traditional to new sectors where buying and selling can happen extremely fast due to the intangible nature of the goods. Pollution rights exchanged on the carbon-trading market, for example, have given rise to huge fraudulent schemes. One networks dismantled in France in 2008-2009 and amounted to a loss of more than €1.6 billion for the French tax authorities.

How the “carousel fraud” works

When a VAT registered trader buys goods from another member state, he does not pay VAT on import, only charging and accounting for VAT when he sells the goods on the domestic market.

On the other hand, exporters do not have to apply VAT on exported goods, and have the right to reclaim the VAT they have already paid.

Fraudsters can take advantage of the system by importing goods free of VAT and reselling them on the domestic market inclusive of VAT. Fraud takes place when that VAT is not passed on to the tax authorities.

For example: Company A in Ireland sells goods to company B in Belgium. No VAT has yet been charged, but when B sells the goods on to C, also in Belgium, VAT is paid by C to B. The latter then fails to pass it on to the tax authorities, pocketing the cash.

Company C sells the goods on to D also in Belgium, who exports the goods VAT-free to France, reclaiming VAT from the state as he does so. And, in theory, so the roundabout goes on.