by Jeremy Woolfe

Brussels — Fraud on value-added tax in Europe is robbing the citizens of the European Union of a massive $100 billion to $120 billion a year — perhaps 10 percent of the entire potential levy.

According to the European Federation of Accountants (FEE), irregularities on VAT have become an increasingly costly problem.

Tax experts from across the continent heard at a recent conference here that the total fraud equals the entire effective VAT take for a large individual country, such as France. The FEE estimates are in line with those from the European Commission, the EU’s central civil service, which inevitably picks its words more cautiously.

However, the commission recently reported to the European Parliament that, “Some member states have estimated such losses at up to 10 percent of net VAT receipts. VAT fraud has therefore become a real worry ... [that] jeopardizes legitimate trade ... and distorts competition.”

Comparative losses on sales tax in the U.S. are guessed to be under a third of Europe’s, at around 3 percent. According to  Chas Roy-Chowdhury, head of taxation at the London-based Association of Chartered Certified Accountants, the U.S. average would be lower than one of Europe’s less problematic countries, the U.K. In Great Britain, losses hover between 3 and 5 percent.

Reasons for the EU’s VAT mess include what Americans would regard as astronomic tax rates, which can exceed 20 percent. There are also the problems of harmonization and co-ordination inevitable among a large group of different countries. Each EU state has a different government, a different tax rate and a different culture.

Having 11 different languages adds to the legalistic confusion.

This is especially the case when there are inconsistencies in versions of the master legal text from one language to the next. Overall, the tax’s complexity in practice makes it very difficult for fiscal authorities to regulate. VAT is supposed to be tax neutral for business, but the commercial sector now finds it to be an administrative and competitiveness nightmare.

VAT works — or is supposed to work — by imposing a levy on business at all levels of the manufacture and production of a good or service. It is based on the increase in price, or value, provided by each level of firm in the manufacturing (or service) process. VAT is technically a turnover tax, but because the final consumer ultimately pays a higher price for the taxed commodity, it is essentially a hidden sales tax.

The system was originally introduced in France in 1954. It was introduced across the EU under a directive, the “6th VAT Directive” in 1977, from Brussels to national governments. It is now a major part of the tax structure of Western Europe.

Between the introduction of the directive and the end of 2001, there have been 21 amendments. But, according to Stephen Bill, an official at the Commission, when the EU got rid of internal customs controls at the national borders in 1992, “what we did not do was get rid of the fiscal frontiers.”

A taxing problem to fix
In the face of the excessive rate of VAT fraud, it is no surprise that the Commission has now decided on a recast of the directive. The idea started with the intention essentially to tidy up the legislation, bringing amendments into the main body. In fact, there have been serious revisions.

Consequently, the new legal text now faces the byzantine ordeal of getting unanimous approval by the European Council. Since EU enlargement on May 1, the governments of 25 member states, with 20 different legal languages, will be involved. One of no doubt a myriad hitches to sort out will be France’s wish for special low taxes on restaurant meals.

National governments hesitate to agree to any tax harmonization, for fear of losing control of their national treasuries.

Apart from the Council, other hurdles will include the need for consultation with the European Parliament. And on top of that there will be liaison with a special body, the European Economic and Social Committee. One bystander forecasts that it will take “some years” to see serious progress.

In the early 1990s, the U.S. briefly considered instituting a VAT system to fund national health care programs, but eventually decided against it.

Bill, speaking at the Brussels conference to highlight Europe’s VAT mess, told the tax experts that even in low-tax America, local sales tax was distorting markets, and resulting in booming mail order “buy-out-of-state” activity.

Europe’s equivalent involved business-to-business “distance selling.” Bill explained that this resulted from VAT rates varying widely, from zero on some special goods (which can follow lobbying by special interest groups), to a “low” 14 percent in Madera. They then go on up to the dizzy heights of 25 percent, in Denmark.

These rates may look horrifying compared with the 6 to 7 percent in Florida and 10 to 11 percent in New York. Part of the VAT fraud problem in Europe is blamed on the insufficient evolution of the taxation system over the last 50 years.

Stephen Dale, of the FEE, said that the European Court of Justice was playing a larger role in interpreting the VAT directive. Working on a case-by-case basis, the court was coming up with interpretations of the legislation that were resulting in less pan-Europe harmonization, rather than more.

On specific scams, Bill mentioned “missing trader fraud,” sometimes called “carousel fraud.” Fraudsters form a ring of companies, make dishonest refund claims on the VAT authorities, then disappear. Their life could become easier now, by taking advantage of the addition of the 10 new states.

In detail, the fraud works when a so-called “conduit company” makes an exempt intra-community supply of goods to a “missing trader” in another EU member state. This company acquires goods without paying VAT and subsequently makes a domestic supply to a third company, called the “broker.”

The “missing trader” collects VAT on its sales to the “broker,” but does not pay the VAT to the treasury and disappears. The “broker” claims a refund of the VAT on its purchases from the missing trader. Consequently, the financial loss to the treasury equals the VAT paid by the broker to the missing trader.

Next, the broker may declare an exempt intra-community supply to the conduit company, which then may make an exempt intra-community supply to the missing trader, and the pattern resumes — hence the term “carousel fraud.”

Dale cited another kind of criminal pattern. A case involved a series of robberies at petrol stations in France. The thieves concentrated not on cash takings, but blank invoice forms and blank till rolls.

Months later, the French tax administration started to receive VAT refund claims from Russian transport companies.

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