WORKING PAPER DIPARTIMENTO DI ECONOMIA PUBBLICA

Working Paper n. 129 Silvia Fedeli e Francesco Forte

EU VAT Frauds

Roma, Novembre 2009

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Silvia Fedeli - Francesco Forte1

EU VAT FRAUDS Abstract The paper analyzes the VAT frauds issues in the European Union after the abolition of the internal customs. All the suggested solutions based on the origin principle create distortions in the “one market” and have a doubtful efficiency. The reverse-charge regime for all business to business transactions joint with VAT at the last stage also creates heavy discriminations. The current system based on the destination principle joint with ad hoc measures - such as specific reverse-charge, rebate and margin regime under evidence that VAT due has been paid, joint/several liability… – and a consistent information-exchange-system may provide a less distorting solution. Keywords: EU Value Added Tax, VAT frauds, carousel, fraud-chain, reverse charge, VIES JEL Code: H26, H29, K33, K34, K42

– November 2009 –

Sapienza - Universita’ di Roma Facolta’ di Economia Dipartimento di Economia Pubblica Via del Castro Laurenziano, 9 00161 Roma – Italy Tel. and Fax +39 06 4976 6399 E-mail: [email protected] [email protected]

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We wish to thank the anonimous referee for the useful comments.

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1. Introduction The purpose of this paper is to analyze the issues of the intra community VAT frauds arising in the European Union. These frauds may be mere intra community trade frauds or frauds of the domestic VAT arising from intra community trade. International VAT frauds may also take place among EU and non EU States. However, the intra community VAT frauds present peculiar features. The harmonized VAT applied in the EU States is a value added tax of consumption-type based on destination principle. According to this principle, goods2 sent from a trader to another State, either to other traders or to himself, must be exonerated from VAT (also for the VAT paid on the goods entering into them), whereas goods introduced permanently3 in any EU State are subject to VAT. With non EU States, there are border fiscal controls to check goods imported and exported. Among the EU States, customs’ controls have been abolished since 1993 with the creation of the “one European market” and the VAT assessment on imports from other EU States occurs at the place of the importers, whereas the right to VAT free exports to other EU States is assessed at the place of the exporters. Although the lack of controls at the border may create occasions of VAT frauds, the negative effects of the abolition of the intra community borders on the VAT compliance should not be over assessed. With customs among the EU states, the controls at the borders for VAT purposes used to be limited. For example, for imports by containers and trucks, a large part of the controls did not occur at the borders nor at the custom houses, frequently congested, but mostly at the domicile of the importer.4 Therefore, the elimination of the intra community customs has not changed dramatically the types of VAT controls. In principle, with an adequate cooperation between the revenue administrations of the exporting and of the importing States, the VAT chain into the EU countries may be reconstructed at the information level. Moreover, with efficient controls at the last stage, the VAT taxpayers are induced to ask for purchases’ invoices to maximize the VAT to be deducted; their suppliers, in turn, are induced to ask for invoices on their purchases to reduce the VAT burden and so on up to the initial stage.5

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By the word “good”, we shall usually mean also “service”.

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Not all the goods coming in a given country from abroad must be subject to VAT there. Those in transit destined to a third country do not pay the VAT in the transit country and, consequently, do not get exemption from it when going out. The VAT is not due also for the goods coming into a given country from abroad, temporarily, to be re-exported unchanged or with small changes to the country of origin, such as those goods sent to an exhibition. 4

This was and still is a common practice also for imports from outside the EU.

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The advocates of VAT suggest that VAT is self enforcing, giving each trader the incentive to ensure that its suppliers have properly paid VAT in order that the former can claim the proper credits. Because of these reasons, Cnossen (1990) considers VAT as the probably best tax ever invented for raising tax revenue. See also Cnossen (1994, 1998, 2001). On the other hand, Hemming and Kay (1981) stress on the illusory notion of self enforcement of VAT. In general, it is recognised

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Nevertheless, several EU States claim that VAT frauds in the intra community trade are responsible for increasing losses of revenue and that the VAT frauds are an important problem. The International VAT Association estimates losses of VAT revenue due to frauds at 60 to 100 billion euros per annum for the European Union as a whole. In the United Kingdom, the HM Revenue and Customs estimated, for years 2005-2006, VAT losses of 18.2 billion euros. In Germany, according to a study of the Ministry of Finance, the VAT losses in 2005 amounted to 17 billions.6 Several factors different from the abolition of the intra community customs help to explain the seriousness of the issue. Amongst others, the fall of the “iron curtain”, the progressive admission to EU of new States with the enlargement of the outside frontier of EU and the increased immigration have eased VAT frauds. The new EU countries often have relaxed tax enforcement and this may be a source of black trade originating VAT frauds in the developed EU States. The new context has also favoured the creation of bogus companies, registered as VAT traders and behaving as missing traders. These companies issue invoices charging VAT, do not remit the VAT to the revenue administration and disappear (see below). The EU enlargement has also broadened the scope for VAT frauds in the “transit traffic” goods.7 BOX 1. Legenda EU = European Union EUC = EU Commission. B to B = Business to Business DVAT =VAT based on the destination principle LOVAT = VAT based on origin principle limited to the intra community operations. VIVAT = Viable integrated VAT (dual rates system one standardized rate for B to B transactions, diversified rates for transactions between B and final consumers). CVAT = Compensating VAT(similar to VIVAT, but the revenues collected on exports are credited directly to the imports’ State) RVAT=VAT with reverse charge system (the legal taxpayer is the purchaser ) BRVAT = VAT with reverse charge for all B to B transactions and standard VAT at the final stage. JLVAT = Joint liability for VAT of purchaser with supplier. SLVAT = Several liabilities for VAT of purchasers and purchasers with suppliers EVAT = VAT with right to rebate on evidence that the tax for which the rebate is claimed really entered the good and was paid BMS = “Bonus-malus” insurance system. VIES = VAT information Exchange System.

The claim that with the abolition of the customs among the EU countries the VAT frauds would have increased was raised, in the EU Commission (EUC) quarters, immediately before this abolition. A shift of VAT from the destination to the origin principle for the intra community trade that business traders under-report sales and purchases invoices in order to avoid income taxation. The emergence of a black chain parallel to the VAT system is modelled by Fedeli and Forte (1999) and by Fedeli (2003). 6

International VAT Association (2007), HM Revenue & Customs (2006) and Monatsbericht des BMF (2006) are all quoted in European Court of Auditors (2008).

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While the payment of the VAT due on the goods in transit is postponed to the country of final destination, transit goods under seal may disappear during the travel to enter the black market.

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was devised by the EUC, who suggested a new type of VAT based on the origin principle limited to the intra community traffic (let us call it LOVAT) by a proposal of directive submitted to the Council (see below). Under the origin principle each state levies the VAT on the value added created in its territory, so that while imports are free from the tax, goods sent abroad are taxed. It was argued that, with a VAT taxing exports and exempting imports in the intra community trade, the abolition of the customs among EU countries, as for the risk of VAT frauds, would have been irrelevant. In spite of its common sense appeal, this claim is incorrect. As for the entitlement of the revenue by the EU Member States, LOVAT was still conceived as a consumption tax based on the destination principle. To recognize to each EU state the VAT on its final consumptions, the VAT collected by any of them on the exports to any other EU State would have to be given to its Treasury. A clearing system, administered by the EUC itself, would have to be set up in order to give to each State its own revenue. This solution would have required a complex technical work and a huge increase of power of EUC in tax matters. Moreover, a correct working of this mechanism requires an extensive harmonization of the VAT rates of the various EU states. Most countries were not ready to agree on the EUC proposal, when the abolition of the intra community borders became effective. The taxation by self invoicing of the importers from other EU countries was, thus, kept as a transitional regime.8 To cope with the abolition of the border controls, other controls, based on exchange of information among the revenue administrations concerned, were prescribed for these intra community transactions. The “provisional regime” has persisted because the EUC proposal encountered a persistent opposition of the majority of the EU countries. Because this regime has been considered transitory, the activities required for the enforcement of the new system of controls replacing those related to the abolished customs has been overlooked by the EUC and by most national revenue administrations. Thus, controls and information for the VAT among the revenue administrations remained greatly defective for the intra community trade. According to the European Court of Auditors (2008) “most VAT evasion is linked to undeclared economic activities (the "shadow economy")”. However, “significant VAT evasion also occurs as a side-effect of the VAT arrangements put in place when the single market was introduced in 1993”. We shall argue that these new occasions of frauds may be greatly reduced if appropriate measures are adopted keeping the destination principle. LOVAT and similar models of VAT based on the origin principle in the intra community trade and credit of the revenue to the importing countries are, in many respects, inferior instruments to cope with these frauds.

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The VAT legislation has adopted neutral terms as goods “arrived” or “received” in a given EU country from another EU country and goods “delivered” or “sent” to other EU countries from other EU countries to emphasize that the abolition of the fiscal controls at the intra community borders (adopted from January 1st, 1993) meant that the intra community trade had to be assimilated to trade inside each EU state.

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The plan of the paper is the following. In section 2, we consider the different types of VAT fraud games. In Section 3, we analyse the various solutions suggested to cope with the cross border VAT fraud problems. Concluding remarks follow in section 4. 2. A stylized anatomy of (cross) border VAT frauds The VAT frauds may be classified as in the following Tables 1 and 2.9 Table 1 considers simple VAT fraud games according to whether they are merely domestic or have an international (intra community) component and whether the payoff consists in tax savings, in undue VAT rebates or both (e.g., some game consists of undue rebates and subsequent sales with fake invoices or no invoice at all).

Table 1. Simple fraud games FRAUDS

SAVING OF VAT AND DIRECT TAXES

UNDUE REBATE

A. Traders sell without VAT invoice or with fake invoice or deduct fictitious VAT amounts from the VAT due.

Traders taxed at reduced rate or zero rate entitled to VAT rebate on the purchases of goods entering in their goods, get the rebate either for non existent goods as documented by fake invoices or for goods that did not actually enter their goods subject to VAT. Exporters claim the VAT rebate on imports entering into their exports, but the importers have not remitted the VAT to revenue administration (missing traders).

MARKET

DOMESTIC B. Traders deduct the VAT charged by bogus companies to whom they have outsourced (part of) their business; the bogus companies do not remit VAT to the revenue administration and disappear or go bankrupt.

INTERNATIONAL

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A. Importers do not pay the tax on imports (because they neither self invoice the goods nor remit the tax to the revenue administration) and sell the goods on the domestic market with fake VAT invoice or without invoice (to consumers). B 1. Importers pay the VAT on the margin between purchase and sale price, pretending that the goods imported (often cars) from a bogus foreign trader are “second hand” goods. The exporters, however, get the VAT rebate on their purchases and charge to the importers a fake high purchase price to minimize the margin. B2. The importer is a private purchaser and is given fake documents showing that the good imported has been already subject to the margin regime in the exporting country.

SAVING OF VAT AND DIRECT TAXES PLUS UNDUE REBATE Traders taxed at zero or at reduced rate sell part of their goods without invoice or with fake invoice and get undue VAT rebates for the VAT on goods that did not enter the goods taxed.

Exporters claim the rebate of VAT on imports entering their exports, the good are formally exported by bogus traders that do not pay the VAT. They remain in the domestic market to be sold with fake invoices or without invoices.

An overall description of the basic types of VAT frauds, evasions and elusions is also in Keen (2007).

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Notice that the international VAT and direct tax frauds also exploit the margin regime. This is a VAT regime applied to second hand goods, on the assumption that they are mostly sold by privates who have paid the VAT on their purchase but cannot charge a VAT on their sales. Thus, the goods bought as second hand goods are charged with VAT on the difference between the sale price and the purchase price. If a car is bought new and exported after a while it may be considered a second hand good, subject to the margin regime in the importing country, even if the VAT paid has already been rebated. If the export price is inflated, the VAT due on margin may be irrelevant. The fraud by the margin regime may also be done by brokers who sell foreign cars to privates, alleging that they have been subject to the margin regime in the exporting country. Table 2 considers the chain fraud games, i.e., the multiple fraud games connected among each other into a chain of transactions. These games may be also classified according to whether they are merely domestic or have international (intra community) components and whether their payoff consists in tax savings, in undue rebates or both. As for the simple games, in the chain games, the VAT fraud may be joint to the evasion of the tax on income and the social security contributions (shortly, “direct taxes”). Table 2. Multiple fraud games FRAUDS

SAVING OF VAT AND DIRECT TAXES

UNDUE REBATE

SAVING OF VAT AND DIRECT TAXES PLUS UNDUE REBATE

Domestic traders sell to other domestic traders goods with fake VAT invoices or without VAT invoices. The latter sell the goods made with them to other traders and so on until the consumers (domestic black chain).

Traders taxed at reduced rate or zero rate entitled to VAT rebate on the purchases of goods entering in their goods, get the rebate for the goods that did not actually enter in their goods subject to VAT and sell them to traders who are subject to the same rates on their sales and get undue rebates in the same way.

Traders taxed at zero or reduced rate sell part of their goods without invoice or with fake invoice to other traders and get undue VAT rebates for the VAT paid on the goods entering these goods claiming that they entered the goods taxed. Their purchasers get undue rebates on the goods bought in the black market with the same claim and so on until the final consumer.

Importers evade the VAT on imports and sell the goods with fake VAT invoices or without invoices to domestic traders who do the same with other traders and so on until the final consumers (domestic black chain with international origin).

Exporters claim the VAT rebate on goods imported that they export in a second country; the importers do not remit the VAT to revenue administration and disappear. In the second country a similar game is played until a sale in the regular market. The goods officially exported to a second country might remain in the first country for a further round of undue rebates (Carousel).10

MARKET

DOMESTIC

INTERNATIONAL

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Carousel followed by (or alternating with) a sale of the imported goods in the domestic market without invoices or fake invoices.

The name given to this chain fraud is “carousel”, because the goods concerned go around from one country to others to get fraudulent rebates.

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The tax saving games in Table 1 and 2 may occur either by omitting the invoices, by issuing fake invoices or by true invoices not followed by VAT remission. The case of simple-fraud is eased for sales to consumers, who might not care of invoices when the purchases have low value or are sold at a convenient price. Sales to the final consumer may also occur with fake invoices not to be registered. Fake invoices may also be issued to registered traders unaware of the fact that the invoices received do not correspond to registered VAT invoices of the sellers. However, fake VAT invoices between registered traders may be used also with purchasers perfectly aware of the fraud: they deduct the fake VAT invoices from their real VAT invoices claiming their “bona fide”. Traders may also under invoice the output value for VAT purposes, saving a reasonable margin of value added. In so doing, they save both the VAT and the direct taxes on the hidden value added. We have also contemplated the case of traders who issue a true VAT invoice but do not pay the tax to the revenue administration, disappearing and/or going bankrupt. This system may be practiced by registered traders who set up bogus companies for imports or for subcontracting (a typical case in construction industry). In the latter case, the taxpayer avoids the payment becoming a missing trader. The customers of the missing trader can be a bona fide trader or be also involved in the fraud. Obviously, also in this second case, he shall claim the bona fide (EU Court of Auditors (2008)). In some cases, the international VAT fraud is the by-product of other illegal activities as imports of counterfeit products and contraband. Some time the goods sold in the black economy are counterfeit goods or goods with fake brands.11 VAT credits entitling to rebates may arise not only for the VAT on purchases entering the goods exported, but also for goods and services taxed at zero rate (because of a reverse charge regime) or at reduced rate (such as agricultural goods, foods, pharmaceuticals, health services, cultural goods). The goods for which the VAT rebate is claimed may not be entitled to it, being consumption goods or inputs for goods exempted from VAT that generally are not entitled to rebate. Notice that these fraud games may easily became multiple VAT fraud games if the traders applying for the rebate purchased part of the inputs of their goods taxed at reduced rate without invoice and sell them without invoice or with fake invoices as it easily happens for foods and other agricultural goods sold to consumers by small business. Given the variety of VAT frauds as from Tables 1 and 2, Figures 1 and 2 present two stylized chains of EU cross border multiple VAT frauds. Notice that Figure 1, relating to chain VAT frauds with international origin, does not present the simplest chain, which would merely include the games of the importer and of his purchaser, but a more realistic chain inclusive of a retailer providing the

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Often these goods are produced and counterfeited in non EU countries; while their “perfecting” is done in the EU black economy.

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consumption market. The chain of players might also include a wholesaler before the producer. In this case the tax fraud would be addressed to provide them (costly) intermediate goods at a reduced price. The chain may be activated by the expected gains at the initial stage, i.e., on the supply side (see Fedeli and Forte, 1999) or by the expected gains at the final stages, i.e., on the demand side (see Fedeli, 2003). Traders who bought without regular invoice, not succeeding in finding purchasers willing to buy without regular invoice may draw self invoices and pay the VAT as if the goods were purchased abroad. Strategies may differ for small retailers and suppliers of services and highly structured firms such as hypermarkets, chains of stores, of hotels and of restaurants. Small shops may ask for VAT free goods to be able to also evade the direct taxes. The highly structured firms may ask for VAT free goods concealed by fake invoices to buy goods at discounted prices to increase their unit margins or/and to make discounted sales.

Figure 1. Chain of black transactions from the purchaser from abroad to the retailer in the same country IMPORTER Exchange of VAT-free goods between the importer and the producer. The importer evades the VAT on the goods imported and sells them without VAT to the producer who, in this way, is able to evade the direct taxes on his production and the VAT on his sales

GAME I

PRODUCER GAME II

Exchange at reduced price of goods without VAT between the producer and the retailer

SHOP GAME III

The shop sells the goods to consumers, without VAT, at reduced price because of the taxes evaded.

CONSUMER

Figure 2, shows a simple type of “carousel”12 with two fraud rebates games and regular sales at the end. However, one might figure out a more complex game with more rebates frauds or/and a black chain with also direct tax evasion. In the case considered, the obvious reason why exporters from C may send back to country B the goods object of the rebate fraud is to exploit the fraudulent organization. On the other hand, carousel frauds might occur merely by multiple undue rebates in country B, by simulating sales from it to other countries’ bogus traders, which sell the same goods back to bogus companies in country B. The goods remain always in country B. Only the invoices go around.

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A basic formal model of carousel is in Fedeli and Forte (2008).

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Figure 2. The carousel over 4 EU countries BORDER

BETWEEN COUNTRY A AND COUNTRY B

BOGUS TRADER I BEHAVING AS MISSING TRADER Bogus trader I, “front man” of fraudster 1, imports VAT-free goods from country A, charges the VAT to fraudster 1 and disappears. GAME 1: Fraudster 1, who purchased these goods, exports them to country C (in agreement with Fraudster 2) and obtains the rebate of the VAT on the goods purchased. FRAUDSTER 1 BORDER BETWEEN COUNTRY B AND COUNTRY C BOGUS TRADER II BEHAVING AS MISSING TRADER GAME 2

Bogus trader II, “front man” of fraudster 2, self invoices the VAT on the goods acquired from country B, sells them with VAT added to fraudster 2 and disappears. Fraudster 2 gets the rebate on the goods purchased from bogus trader II and exports them to country B to a further bogus trader.

FRAUDSTER 2 BORDER BETWEEN COUNTRY C AND COUNTRY B Exporter from country C sells the good to bogus trader back to country B to continue the carousel. The game ends with sales either in the legal or in the black market. BOGUS TRADER III BEHAVING AS MISSING TRADER

One may ask why one needs to employ the same goods to get illicit rebates in different countries, i.e., why it pays to set up a carousel. The answer is that the firms asking for rebates on exports may be asked to show to the revenue administration the goods object of these sales.13.

3. Analysis of the various solutions suggested to cope with the VAT cross border fraud problems. 3.1. Global solutions adopting the origin principle for the intra-community trade: “LOVAT” (limited origin principle), “VIVAT” (viable integrated VAT) and “CVAT” (compensating VAT) The EUC has formalized its ambitious global solution, which we have named LOVAT (limited – origin-principle-VAT), in a draft of Directive of 1996. Under this scheme goods sent from traders in an EU State to other EU countries shall be subject to VAT in the country of origin. The goods arriving in any EU country from other EU countries would not be subject to VAT by self invoicing. On the contrary, the VAT paid in the other EU country shall be deductible from the VAT due on the transaction in the domestic market of the importing country. The VAT collected on the goods sent to other EU countries shall be considered a debt of the state of departure and a credit of the State of 13

Carousel frauds often range over several member states and involve numerous companies. Eurojust reported, March 2007, a case of international VAT carousel fraud estimated at 2.1 billion euro and involving 18 member states. See Eu Court of Auditors (2008).

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arrival. The yearly difference between VAT debts on exports VAT credits on imports of each EU State shall give the State VAT credit or debt for the year. In order to administer the system, a clearing fund, managed by the EUC, would be instituted. The VAT debts and credits would be assessed by statistical indicators of the flows of the intra community trade assessed either on micro or on macro data on the trade among EU countries.14 While the traders taxed with VAT on their deliveries to other EU countries have the obvious incentive to underreport them, the revenue administrations of their States may not have incentives to control them, given that the VAT revenue has to be destined abroad. On the other hand, the VAT taxpayers in the importing countries shall have the incentive to over-asses the value of the goods imported from other EU countries, because the VAT is deductible from the VAT on their sales. But the revenue administrations of these states shall have a low incentive to check these taxpayers if the VAT invoices on imports are used to assess their VAT credits.15 Delivery documents and arrival documents, therefore, may not coincide, thus, creating problems for the clearing operations. To overcome these problems, the equalization might be based on macro indicators: methodological controversies, then, shall arise about the proper indices (Genser, 2003). In both cases of micro and macro indicators, some authority in the EUC or in the Council shall be given a discretionary power of settlement. The costs of administration would increase and the acquisition of the revenues of competence by each member country shall undergo delays. Because exports to other EU countries are taxed, LOVAT eliminates the frauds related to VAT rebates for these exports, but it does not provide a solution for the rebate frauds for exports to non EU countries. The shift to the origin principle for the intra community trade, per se, does not restore the chain of transactions interrupted by the destination principle. Under a system of VAT assigned to the different States of the Union, the interruption of the chain is due to different revenue administrations operating on the departure and arrival sides of the goods. This happens also with taxation in the place of departure. The shift to the origin principle merely changes the type of the fraud problem caused by the interruption of the chain. Under LOVAT, the registered traders in the State of arrival of the goods may manipulate the documents to inflate the cost deductions for the domestic VAT. To this end they may either use fake export documents self-created or fake documents provided by exporters. When the goods belong to the same owner, this shall be much easier. Beside this point one must also notice that the allegation that LOVAT models the VAT chain in the EU cross border traffic mimicking the VAT chain for the domestic trade is untrue: a large part of the circulation of goods and services among the EU countries does not consists of transaction between traders but of deliveries of goods from the plant of a firms in one EU country to other plants of the same firm in other EU countries. LOVAT taxes 14

Presumably Eurostat shall have the new task of working out and applying these statistical indicators. For a short but exhaustive critical discussion see Genser (2003).

15

For a criticism of these proposals, see Genser (2003).

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these cross border deliveries at the place of departure, while, in the domestic traffic, they would not be subject to VAT. This fact may create unexpected distortion in the EU unified market. Occasions of fraud shall arise also for the assessment of the value of the goods delivered to the other country’s own plant, in the absence of a contractual document of sale.16 To overcome these problems, if LOVAT exempted these deliveries of own goods from one EU country to another, difficult questions would arise about the definition of the intra community deliveries that do not give origin to a VAT transaction among different entities, given that the VAT subjects, in the country of departure and in the country of arrival, in any case, are subject to different tax administrations and any way, are different taxpayers with a different tax code. The cost of administration and the room for tax frauds may increase. To avoid intra community trade discrimination due to differences in the VAT rates falling on the domestic value added of each EU state and to ease the clearing of the VAT debts and credits of the various EU States, the EUC draft Directive proposed an extensive standardization of the LOVAT rates. Actually LOVAT satisfies the inner tendency of the EUC to centralization. It may also be instrumental to increase the tax power of the EU by a gradual transformation of LOVAT in CVAT as applied in Brazil (e.g., a dual VAT based on the origin principle, with a rate due to the Federal government on all the Business to Business (B to B) transaction and the VAT on the sales to the final consumers belongs to the different States, who may apply different rates, see below). EUC might aim at this solution, by gradual steps, beginning with the appropriation of a share of the equalization fund as a substitute for the share of VAT that each State has to give the EU in order to finance the EU budget. This EU share, increased to finance new EU expenditures, may be transformed in a B to B VAT rate administered to the EUC.17 Many members of the EU Council were not convinced of the reasonableness or of the feasibility of the LOVAT. Thus the Council has prolonged the transitional period for an indefinite number of years, without specifying how the final system shall be.18 More than ten years after the draft of directive of 1996, in the June 2007, from a Council document19 on the ways to combat the cross border VAT frauds, it emerged that a large number of Member States objects the shift to the 16

Under the present VAT regime, the VAT on goods imported from other traders, in principle, is applied to the value of the goods purchased, as resulting from the invoices exhibited by the importers. For the goods imported from own firms abroad, for whom it does not exists a contractual value, the taxable basis of VAT is determined by multiplying the current market value in the importing country of the goods imported by the quantity reported by the importer. An under assessment of the value of the goods imported may allow to under value the sales done by them, with a saving of VAT and direct taxes on the true margin thus concealed.

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EUC is actually in search of new revenue sources to finance the new policies. They might be better financed by cutting other objectionable expenditures. 18

Number 10 of the preamble of Council Directive 112 of November 28, 2006 explicitly recognizes the need for a transitional period in which intra community trade has to be taxed in the member state of destination in accordance with rates and conditions set by that member state.

19

Council of the European Union, Combating tax frauds, provisional version of 5/6/2007.

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origin principle pointing out that “the clearing procedure needed for this solution posed a problem”. Only “about half of the states have come out in favour of further consideration of this system”.20 To overcome the criticism to LOVAT, a dual VAT model, named VIVAT, has been suggested by Keen and Smith (1996 and 2000).21 VIVAT, as LOVAT, would be based on the origin principle. Unlike LOVAT it consists of a section for all B to B transactions with the same tax rate, substantially lower than the present top rate of VAT in all EU countries, and of another section for the sales of business to final consumers, allowing differentiation of the rates, in the various EU States within an harmonized scheme setting the top rate and the minimum rates and the list of possible exemptions. Because the B to B section of the tax would cover both the domestic and the intra community B to B transactions,22 it is claimed that VIVAT would be neutral in the intra community trade. On the other hand, the deduction of the B to B uniform VIVAT rate paid on the purchases from the differentiated VIVAT charged to the consumers shall assure that the entire value of the domestic consumption shall be taxed with the VIVAT rates chosen by each EU state.23 The clearing of the VAT debts and credits related to intra community operations would be eased by uniform rates of the B to B and could be administered bilaterally by the States concerned. The administration of the clearing system would engender extra costs and delays in the perception of the VAT revenues by the entitled States, but extra costs and delays would be minor as compared with those of LOVAT. However, as LOVAT, VIVAT eliminates the frauds on the rebates of the exporters to other EU countries but not those relating to the exports to non EU countries and, as LOVAT, VIVAT cannot extirpate the frauds connected with the interruption of the VAT chain, in the intra community trade, arising from the fact that exports and imports are assessed by different revenue administrations. As under LOVAT, exporters shall have an incentive to undervalue the goods sent to another EU country to pay a lower VIVAT, while the revenue administration of the exporting country may not control them efficiently because the revenue has to be credited to another country. As under LOVAT, importers might inflate the value of the goods imported to show and higher VAT on them to be deducted from the VAT on their sales. As under LOVAT, the revenue administration of the importing countries who, by these frauds, gain revenue shall have no interest in contrasting them. 20

Council of the European Union, Combating tax frauds, provisional version of 5/6/2007: 1.b) Taxation in member state of departure, 2nd indent, point 4.

21

See also Keen (2000a, 2000b and 2007).

22

We adopt the word “operation” and not “trade” because to operate without loopholes the tax on exports needs to be applied also to the goods delivered to another EU state within the same firm. Two premises of the same business in two different countries should have, as now, two different VAT codes, because subject to different tax jurisdiction, even if the taxpayer is an identical legal person.

23

The tax rate on purchases, under the system of deduction of the VAT paid from the VAT due, is irrelevant to determine the final tax burden on the good taxed. Only the rate at the final stage determines the effective burden on the full value of the good taxed, because the previous rates are absorbed in the next rates.

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The claim that VIVAT is neutral in the intra community trade, because the B to B rate for domestic and intra-community transactions is identical, is not correct. Indeed, as under LOVAT, with VIVAT goods sent by traders to their firm in another Member State shall pay the VAT at the place of departure, while the traders who send goods from one plant of their firm to another of the same firm, in the same State shall not pay the VAT. Furthermore, with a rate of 10% on B to B, the goods taxed at the final stage with lower rates, such as the 5% EU standard reduced rate, shall undergo an excess burden in the B to B transactions, while claims of rebates may arise at the final stage, with the risk of rebates frauds. The biggest problem, however, is disentangling the B to B transactions subject to a VIVAT low rate and the transaction of business to the consumers subject to higher VIVAT rates for the various taxpayers. Retailers may be obliged to apply the final rate also to sales to business operators, to avoid the possible fraud consisting in applying the B to B low rate for those purchases related to private consumption and not to business. This rule to the suppliers of services is, in general, impossible to be applied. Truly there are services, as those of hotels and restaurants that are typically offered to consumers. For other services, such as those of transportation, it may be possible to distinguish those given to the persons from those given to the goods and to assign to the former the high VAT rate at the final stage and allow the reduced B to B rate only to the latter. Nevertheless, legal and technical services and those of maintenance and repair of building are done both for privates and for business. As for public utilities, by subscriptions, it is possible to distinguish those given to business from those given to privates, but if the VAT for the former is lower, the owners of small individual firms shall find it convenient to purchase them on the name of the firm. In the case of supplier of goods to business, it may be convenient for the purchasers to ask for the business goods that shall be devoted to private consumption to get the reduced rate. While the firms allowed to differentiating the rates for the sales to business and to privates shall have additional costs of compliance. New room for VAT frauds may arise and the control of these frauds shall increase the costs of administering VIVAT. On the other hand, it is true that, unlike LOVAT, VIVAT shall not require the extensive standardization of rates and may work without the bureaucratic equalization fund administered by EUC, because, given the standard rate on each B to B transaction, the tax revenues’ equalization among the EU states may be done on a bilateral basis. Yet, if a new bureaucracy in Bruxelles is spared, new bureaucratic costs for the bilateral collaborations are needed. CVAT, suggested by Varsano (2000) and by McLure (2000) on the basis of the experience of federal States like Brazil, overcomes the problems arising from the interruption of the VAT chain among EU states that both LOVAT and VIVAT imply. CVAT as VIVAT is a dual VAT system, with a uniform rate on any B to B operations equal in all Member States and a rate on the transactions to the final consumers, diversifiable by each Member State. CVAT differs from LOVAT and VIVAT because the VAT paid by business selling goods in the intra community market would be immediately 14

credited to the revenue authority of the country of destination. In this way, the VAT chain between the member state of departure and destination should remain uninterrupted and no clearing system is needed. The rate adopted for the B to B, unlike in the proposal of Varsano and Mc Lure, may be diversified to avoid VAT frauds arising for the reduced B to B rate. The registered traders in the state of destination shall deduct the rate actually paid by the exporters on the VAT due by them in order to determine the CVAT due to the revenue administration of their State. With a developed banking system, the payment of the CVAT due to another EU revenue administration, for goods sent in another State, shall be done through bank. The exact indication, by the trader in the State of departure, of the VAT code of the trader in the State of destination and an information system allowing the revenue administrations of both States to know in real time the operations of these traders are essential to this scheme. The biggest problem would be to assure that the revenue administrations of the departure States make the effort of collecting correctly the CVAT from their taxpayers even if the revenue has to be credited to a foreign Treasury. Some of the departure States may even favour the CVAT evasion on these transactions to improve the competitiveness of their business in the “one market”. Thus, there is a high risk of flows of black market transactions arising in the intra community trade. This is not the only problem with CVAT if applied by the European States and not by a federal government. The intra community circulation of goods of the same trader cannot be controlled by invoices and international payments, but only by transport documents whose value is not certified by any document of payment in the country of destination. If this traffic was VAT free in both the EU country of departure and of arrival, a great room for frauds might arise; if it was taxed in the country of origin, the problems of fraud might be greater than in case of exports based on contractual agreements, because of the lack of documents of payment. Generally speaking, for the reduction of tax frauds, the only efficient solutions are those giving the power of tax assessment and collection of the resulting tax revenue to the same revenue administration entitled to it. 3.2. Solutions under the destination principle: BRVAT (reverse charge at all B to B stages and VAT at the last stage). Strategies oriented at locus of highest frauds: RVAT (reverse charge in given case), EVAT (rebate paid on evidence that VAT has been paid) JLVAT and SLVAT (Joint and several liabilities) Let us come back to the existing system of VAT based on the destination principle, i.e. DVAT. With the abolition of the customs for the intra-community trade, DVAT has to rely on the self invoicing at the place of the importers. It is claimed that this way of assessing the VAT, by its nature, opens to the frauds. This system, however, presently adopted for the intra community imports, is not peculiar to them, it is a more general system of VAT assessment, known as “reverse charge”, that cannot be considered per se a factor of weak enforcement. This technique of VAT taxation, actually, is normally applied, under the RVAT to the purchases of the registered traders from non registered traders and to the purchases of second hand goods and art goods. Self invoicing is strongly suggested for the 15

purchase of financial assets and insurance indemnities, to submit financial intermediaries and insurances to the VAT on their services.24 As we shall see, several cases of adoption of RVAT at the domicile of the perceivers of the goods have been recommended, by the EU directives, to combat VAT frauds. The real problem for the reverse charge system as applied on intra community imports is the interruption of the VAT chain, due to the fact that exporters and importers have different VAT codes and are under different VAT administrations. This problem also arises with LOVAT, VIVAT and CVAT. There are two interconnected reasons to keep the DVAT in spite of some difficulties in combating the frauds connected with the intra community trade. First, this type of VAT assures fiscal autonomy to the EU member states and, so far, the EU is not a federal state, but a federation of states. Second, this autonomy implies that the state that makes assessment and collection of VAT keeps its revenue and therefore it has a powerful incentive to combat the (intra community) frauds. Efficient administrations are rewarded by positive revenue results, with the inefficient ones penalised by the loss of revenues. Fiscal federalism implies fiscal responsibility. Some constraints, however, should be observed in relation to the “one market principle”. First, because free circulation is a pillar of the EU single market, any policy reducing VAT evasion has to be conceived and applied under this constraint. Second, because competition is a basic requisite of the EU single market, any discriminatory treatment in a member state should be avoided by both national operators and other operators.25 Third, the harmonization of the VAT among the EU states and, therefore, its character of a fractional tax on consumption must be preserved.26 Under these constraints, some “far reaching solution” must be rejected. This is the case with the BRVAT (reverse charge for all B to B and VAT at the last stage), debated in the EU Council,27 on proposal by Austrian and German representatives28 and, less clearly, by those of the UK29 perhaps as a

24

On the inclusion of insurance premiums and financial intermediation services in the VAT chain, by applying the reverse charge system to the financial assets acquired by the insurances and financial intermediaries from non commercial subjects, see Barham et al. (1987) and Zee (2005).

25

According to Council of the European Union, Combating tax frauds, provisional version of 5/6/2007, the measures should conform to following principles: (i) reduce considerably the possibilities for fraud and exclude new important fraud risks; (ii) generate no disproportionate administrative burden for traders and tax authorities; (iii) ensure non-discriminatory treatment in a member state of both national operators and operators established elsewhere. These preconditions, according to the EUC, imply that, as long as VAT is the EU general consumption tax, those changes that systematically and generally alter the principle of fractionated payment, the VAT key elements, should be precluded.

26

This requisite has been underlined by the Commission.

27

Council of the European Union, Combating tax frauds, provisional version of 5/6/2007.

28

With a letter to the EUC of October 27, 2005, Austria signalled its willing to introduce a general reverse charge system for all the B to B transactions, with yearly invoices of more than 50,000 euros or single invoices of more than 10,000 euro. Germany with a letter of April 8, 2006 expressed the same willing, as for invoices of more than 5,000 euros.

16

way to bargain for much more limited solutions. BRVAT consists in the adoption of the VAT reverse charge system for all the B to B transactions of traders with revenue above a given amount and concentration of the VAT at the last stage. Under this system the transaction of medium and big traders shall never be subject to VAT by reverse charge, except in case of sale to non business. Indeed, business traders subject to reverse charge cannot deduct the VAT paid on their purchases from that due on their sales if these are subject to the reverse charge discipline. Therefore, the only VAT subjects under BRVAT, as for the medium and big business, shall be those at the final stage, who cannot shift to their purchaser the legal position of VAT subject. Medium and big traders who sell to non business traders shall be VAT subjects of two VAT: one on the reverse charge on their purchases and one on their sales to consumers or non profit exempt from VAT. The former VAT shall be deducted from the latter. The result would be much similar to a single stage sales tax, like the old British sales tax. Many business traders shall be, not only VAT free, but also entitled to VAT rebates for purchases from small business subject to VAT. Clearly this dual VAT regime between small, medium and big firms creates distortions in the EU single market, within the same country and among countries with a prevalence of big and small business. It is unlikely that all the EU States would renounce to the advantages of fractioning the tax. Under high VAT rates, with the 20% prevailing rate in the EU harmonized VAT, particularly for countries where small businesses (retail trade and services) are important, the fractioning may appear essential for combating the tax fraud at the last stage.30 Actually BRVAT has been advanced as an option for the EU states that prefer it.31 But if BRVAT was optional, it would be applied only by some EU with medium and big companies pressing for it. The competitiveness of the companies of the Member States applying BRVAT to medium and big business would increase against the Member States requiring the VAT on any business32 and the uniqueness of the EU market would be lost. Therefore, rightly, the EU Council considers BRVAT unacceptable as a far reaching solution. The strategies to combat VAT frauds, as for the intra community trades, by modification of the general VAT rules, under the above considered constraints, must be limited to the areas with the

29

The British Exchequer Gordon Brown told British Parliament in December 2006 that he had planned to change UK’s VAT system into a sales tax in order to stop cross border fraud racket involving mobile telephone and computer chips. It is not clear to how many items the UK would extend the sales tax. The statement has been reported by the Financial Times.

30

The generalized controls at the last stage, ceteris paribus, are much more expensive than at the beginning of the chain, because the number of transactions is much greater.

31

Council of the European Union, Combating tax frauds, provisional version of 5/6/2007, 2) Introduction of a general reverse-charge system,1rst indent.

32

Council of the European Union, Combating tax frauds, provisional version of 5/6/2007, 2) Introduction of a general reverse-charge system, 2nd indent, points 1 and 2.

17

highest likelihood of fraud.33 In this frame, the reverse charge system, i.e., RVAT, might be applied, optionally, in specific cases and sectors. The Council directive 69 of 24 July 2006 has authorized all member states to adopt RVAT for scrap and waste material to be recycled, to sub contractors of constructions and to the sale of buildings and to other cases to which, they believe it might be appropriate subject to Council authorization.34 For the UK, the Council authorized RVAT - with a decision of 16 April 2007 - to prevent domestic and carousel frauds for mobile phones, computers chips and micro processors.35 For Portugal and Greece, RVAT has been granted by the Council for the supply chain of waste materials in the sector of ferrous and non ferrous metals with a motivation referring to carousel.36 Italy with the financial law of December 27, 2006, n.296, has introduced the reverse charge system for computers, some radio-mobile devices and gravestone material. Actually, RVAT has been authorized by the EU Council, in many cases, in different countries.37 However, the extension of sectoral RVAT has severe limits, because it would create complications in the VAT system for registered traders operating both in the sectors subject to it and in other sectors. A workable measure, as for the rebate frauds, may be the system of allowing the rebates of VAT credits only under documentation that the VAT to be reimbursed was actually paid. EVAT (e.g., evidence of the right to VAT rebate) was suggested by Sinn, Gebauer and Parsche (2004) referring to its adoption in Bulgaria, as for the export rebates.38 The system appears effective in extirpating undue VAT rebates, related to missing traders on the purchase side and may be extended to the undue rebates 33

See the Communication of the Commission of the European Communities 31/5/2006 to the Council, the European Parliament and the European Economic and Social Committee, concerning the need of developing a co-ordinated strategy to improve the fight against fiscal fraud. See also European Commission (2006).

34

In order to prevent frequent frauds in the domestic trade the Council has granted to Lithuania the RVAT for the sectors of recycling of ferrous and non ferrous materials, for the domestic trade of timber and for the construction sector, in relation to VAT invoiced by subcontractors “who subsequently disappear”. 35

The Council has granted it to the UK “but only under certain conditions and exclusively in the case of mobile phones and computer chips/micro processors”. The measure “will be valid only for a short period”. This measure has been advocated by UK for a longer list of electronic items such as devices used for the storage, processing or recording of electronic data, cameras, audio players, video players, wireless devices providing e-mail, telephone, text messaging, handheld computers, satellite navigation systems, games consoles.

36

See Decision of the Council of the European Union 6 June 2006 on proposal of the EUC of 2 June 2006. The Council has recognized that “A characteristic form of evasion is that a business within the waste material supply chain does not pay the invoiced VAT to the tax authority after reselling the raw materials yet their customers are able to deduct the tax legitimately”. The result, according to the Council statement, is reduced state revenues (Portugal had estimated that in 2005 VAT was not paid in relation to 44% of the VAT returns submitted in the waste sector) as well as the supplier obtaining an unfair market advantage, which adversely affects legitimate businesses. Greece had similarly encountered revenue losses in this sector.

37

At the beginning of 2006 the number of special measures derogating from the common system of VAT authorized by the member states to combat tax frauds or evasion or to simplify its collection were 140. See Bosch (2006).

38

Sinn, Gebauer and Parsche, (2004) suggest a system of VAT accounts, which requires traders to open a distinct bank account for the VAT charged to their customers. Tax authorities have simply to check whether the amount claimed has been paid any time the rebate claim is not clear. In the same vein, Poddar and Hutton (2001) suggest that goods are not allowed to clear customs until the authorities receive confirmation and guarantee that import VAT has been paid: the problem here is that this system reintroduces restrictions on intra-community trades (see Keen, 2007).

18

and VAT exemptions for exports that did not really take place. The essence of the scheme consists in reconstructing the VAT chain either back or forward, to check the tax compliance at the different stages. The firms who apply for rebates normally do not know in advance whether the suppliers of the goods purchased for exports shall pay their VAT. If the exporters required their suppliers some collateral, as guarantee of the effective payment of the VAT, the costs of these supplies would increase. Therefore if EVAT was applied for rebates related to intra community exports and not to rebates for other exports, a discrimination against the circulation of goods in the “one market” might be created. If EVAT was extended to any export the competitiveness of the EU business in the international trade might be somewhat harmed. To overcome these objections EVAT might be required, for a given number of years, say two, only to the new exporters and to those who got undue VAT rebates. The period of application of EVAT may be increased, in cases of particular gravity. This solution would be similar to the “bonus-malus” insurance system (BMS).39 In this way, companies, formed merely to perform rebate frauds and disappear, shall be discouraged from doing so. In general, these rebate frauds will have a limited room. EVAT, as said, might be also applied for the rebate fraud done through fake exports of goods that remain in the country. In this case the exporters might be required to get, from their purchasers in the other EU State, merely the evidence that they had made the self invoicing. In case of VAT fraud by the purchasers, the exporters might be required of evidence, for some years, that the VAT payment has been made. The system could be adopted for particular sectors where the risks of these frauds appear important. Obviously, the system would work well if it was possible to check, by information network and cooperation among the EU States, whether the importers complied with their VAT obligations. EVAT could be applied, with some modification, also to combat the VAT frauds occurring by an undue margin procedure. It might be required that payment actually took place and that the tax had not been rebated. The application of the margin regime for the imports of “second hand” goods, such as cars, might be conditioned to the evidence that the VAT on the sale of the new good was paid and not rebated. Other measures against collusive VAT frauds, both in the domestic and in the intra community trade, are JLVAT and SLVAT, i.e., respectively, joint and several liability of the purchasers with the sellers. JLVAT has been suggested for exporters with importers when information for VAT purposes has not been (correctly) provided for the considered transactions.40 The measure might be adopted also for rebate frauds, particularly to combat carousel frauds. JLVAT and SLVAT might be adopted to contrast VAT chain frauds for some commodities and for some kind of contracts where the risk

39

“Bonus” means a discount in the premium given if no claim has been made the previous year and “malus” an increase in the premium, according to the claims of previous years.

40

See Council of the European Union, Combating tax frauds (2007), I Conventional measures, 3rd indent, 3rd point.

19

appears particularly high.41 Indeed, by these measures, the chain nature of the fraud has a remedy of the same nature. JLVAT and SLVAT, however, to join the VAT liabilities implies to join the fraction of VAT due at the considered stage. Therefore an extensive application of them runs counter the VAT principle of fractioning the tax burden among the traders producing value added. Furthermore, if extensively applied to the intra community operation JLVAT and SLVAT run counter the “one market” principle. To overcome these objections, they might be applied together with the BMS technique already suggested for EVAT. 4. Policies to combat VAT intra community frauds also by means of information network based on mutual interest of EU States and EU coordination. Concluding remarks. Ideally, under an efficient information system, the States of origin of intra community exports should be able to check whether the goods destined to other EU States have really reached the place of destination and the States of destination should be able to check whether all the goods delivered to them from other EU States have been properly subjected to VAT in their jurisdiction. Because of the mutual interest to have an efficient information system on the intra community transaction, one would expect that such a system already exists and works adequately, by a reciprocity game among the revenue administrations of the EU Member States. However, this is not the case. Truly, an ambitious electronic network of information on VAT, named VIES (VAT information Exchange System), has been set forth in the EU since 1993, to cover not only the intra community transactions but all the VAT transactions taking place in the EU. However, it does not work efficiently, particularly for the intra community trade. This outcome may be explained in three ways. (i) Some administrations are unwilling to cooperate because are not (directly) interested in checking the VAT frauds. (ii) The system is too broad and complex and the cost of providing the information (inclusive of the loss of confidentiality) may exceed the benefits of combating the frauds for which it might be most useful to combine the information exchanged. (iii) An efficient exploitation of the huge amount of different data of an electronic net, nourished by different states, requires clear standardized rules for the information to be sent, in real time, under the control of a supervisory body endowed of adequate authority. So far this has not been done. The description that we have found of the actual functioning of VIES provides abundant evidence that all three explanation of its poor functioning are valid. To make VIES operational, all the VAT codes of the registered traders of all EU States have initial letters of identification of that State, followed by the individual codes of the traders, with name and address in given date. Each national revenue administration should send to VIES the VAT identification numbers of the traders registered in their jurisdiction. VIES information service, in 41

Has been authorized by the EU Council for the timber trade to Latvia.

20

principle, should enable both the revenue administrations and the traders to check on-line any VAT taxpayer by its code. However, only eleven Member States display the traders’ names and addresses when checking the VAT codes. Three States display only the name of the trader; the other thirteen confirm only the validity of a VAT code, without providing any information on the taxpayer. Thus, the information provided is not fully reliable because of different interpretations of the beginning and of the end of the activities subject to VAT. There is no common EU rule on the conditions to get a VAT code and on its cancellation. Some Member States update their databases with retroactive effect. This makes it impossible to verify whether a given VAT code was valid at the time of the transactions under examination. According to the present rules, each administration should deliver, at least within three months, to VIES the detailed list of the VAT operations done in its jurisdiction, with separate indication of the intra-community ones. Because VAT taxpayers have three months to transmit their data to the revenue administration and this information has to be sent to VIES within other three months, the information on intra-community movements is available on VIES only six months later, at best. Yet according to the EU Court of Auditors (2008), there are frequent delays in the transmission of these data, that reduce substantially the reliability of VIES. There are discrepancies between the deliveries reported by the exporting States and the arrivals in the importing ones. The absence of common rules on how to assess imports and exports makes it impossible to know whether the discrepancies derive from the different methodologies or from frauds.42 The rules on the standardization of the data to be sent to VIES by the various administrations have been continuously delayed. A Council Regulation in 200343 (adopted only ten years after the abolition of the borders among EU Member States) demands to the Commission assisted by a standing committee on administrative cooperation the task of determining the exact categories of information to be exchanged, the frequency of exchange and the practical procedures to exchange information. Each Member State determines whether to take part in the exchange of a particular category or information and whether to do so in an automatic or semi automatic way. Few improvements have been done.44 The 2003 regulation considers two groups of cases in which a cooperation of the revenue administrations among them and /or with EUC may be required:45 42

The EU Court of Auditors (2008), for example, found discrepancies between deliveries from the Czech Republic and arrivals in the Slovak Republic caused, amongst others, by different methods for identifying the VAT pertaining to the various quarters.

43

The Regulation (EC) 1798/2003 of 7 October 2003, which entered into force on 1 January 2004, repealing the former Regulation (EEC) No 218/92. When adopting the regulation in October 2003, the Council stated that there had been until then an under-use of the arrangements for administrative cooperation. The Council called for exchange of information to be made more intensive to combat fraud more effectively. See EU Court of Auditors (2008).

44

This occurred with the Council directive 69 of July 24, 2006 merged in the Council directive 2006/112/EC of 28/11/ 2006 on the common system of value added tax aiming at the standardization of the VAT for the identification of the VAT taxpayers, for the assessment procedures, for the payment by invoices and for the format of these invoices. Articles 206-

21

1) Member States may ask for more detailed information on specific request, when their inquiries through VIES give rise to suspicions about a transaction or as a result of risk analysis. 2) Member States may provide information to other Member States without prior request by them, for example when they believe that a VAT fraud has been committed in this other state. The exchange of information has still a very modest frequency. The number of information requested in 2006 has increased only 11.3 per cent on those requested in 2003, the last year before the new regulation.46 In 2006 only 29381 requests were made, concerning the 15 “old” EU States. Because in 2006 more than 3.3 million EU traders reported intra community VAT transactions in these States, even assuming that all the exchanges of information requested concerned different traders, the probability that any of them being subject to such enquiries by VIES was below 0.9 %. According to the findings of the EU Court of Auditors, half of the information exchanged upon request does not take place within the one month time required by the regulation and the delay varies considerably among the states.47 Sometimes there is a significant difference between the number of requests which a member state claims to have received from the other Member States and the number of requests that the corresponding member states claim to have sent to it. The difference may be explained either by some disorder in the organism in charge of responding to the requests or by the fact that the requests were made to the wrong places, maybe because of the difficulty of finding the right address.48 The Member States have failed to set up adequate administrative structures and/or procedures for ensuring efficient cooperation and they tend to postpone these services for the other states to the domestic activity of control. The States interested in the exchange of information seem to 226 give standardized norms for the identification of VAT traders and the persons obliged to become VAT taxpayers. Among others, article 207 States that Member States shall take the measures necessary to ensure that persons who are regarded as liable for payment of VAT in the stead of a taxable person not established in their respective territory comply with the payment obligations. Member States shall also take the measures necessary to ensure that those persons who are held to be jointly and severally liable for payment of the VAT comply with these payment obligations. Article 226 requires compulsory details on the invoices drawn so as to always recognise the person or company liable for VAT payments. Articles 232-237 regulate the exchange of invoices by electronic means. Article 249 disposes that where a taxable person stores invoices, which he issues or receives by electronic means guaranteeing on-line access to the data and where the place of storage is in a member state other than that in which he is established, the competent authorities in the member state in which he is established shall have the right to access those invoices by electronic means, to download and to use them, within the limits set by the rules of the member state in which the taxable person is established in so far as those authorities require them for control purposes. 45

The regulation does not preclude more comprehensive mutual assistance on the basis of other legal acts, including bilateral or multilateral agreements. Where member states conclude additional bilateral arrangements on administrative cooperation, they are required to inform the Commission and the other member states thereof without delay.

46

See Table 1 in EU Court of Auditors (2008).

47

The record in 2006 is of Portugal with 78% of late replies, followed by Italy with 64.9 and Spain with 62% and Denmark and Netherland with 61. France and Czech Republic follow with 55 and 54%, while Ireland is at 49.5, the EU average of late replies and Germany slightly below with 46%. See Table 2 in EU Court of Auditors (2008)

48

The record of discrepancies between the number of requests received according to the Ministry of destination and according to the Ministries of origin belongs to Italy with a 54.2%, followed by Germany with 32.6%. Above 10% there are other 4 states: Cyprus (18%), Hungary (13), Greece (11%) and Sweden (10.9%).

22

be caught in a sort of prisoner dilemma. Because many other States do not cooperate and the rules of cooperation are not clear and well enforced, in many cases the cooperation has a poor reward as compared to the cost. To escape the trap of this prisoner dilemma, an authority enforcing the cooperation seems to be needed. The 2003 Regulation, however has recognized to EUC a mere role of promoting a better cooperation, but not the authority to enforce it, whenever a severe problem of VAT frauds is at stake. One the other hand, perhaps VIES overly ambitious tasks make it hard to enforce a full cooperation among the Member States. To combat the intra community VAT frauds, it seems better to aim at a less ambitious net of information, which might be realized by a subnet of VIES merely related to intra community trade. The revenue administrations of the Member States should send to it, under EUC supervision, the data relating to the VAT collected on imports from the other EU States and the data on the VAT free exports to the other EU states. Each revenue administration of any Member State would have the automatic right of consultation of the VAT data relating to its trade with any other EU State. Selective controls of consistency of invoices of exports and self invoicing on imports, under EUC supervision, would be done.49 Actually a similar information net operating in real time as for the intra community trade has been proposed in the literature for VIVAT and CVAT. Keen (2007) argues that VIES can be employed only to verify analytically that “exports reported in one Member State as going to another duly turn up as import in the latter”. If this is feasible under VIVAT and CVAT, why not to keep the present DVAT system, which preserves the full VAT autonomy and responsibility of the Member States? Under DVAT, limited changes of VAT, consistent with the above considered constraints, may be proved effective in combating some of the most common intra community VAT frauds. RVAT has been effectively employed in cases of high risk of fraud and may be further extended. For missing traders, rebates frauds and carousel frauds, EVAT, applied with rules similar to BMI, might be a very efficient measure. Frauds related to the margin taxation may be contrasted in a similar way. EVAT may be also applied in the intra community trade to reconstruct the VAT chain between exporters and importers. JLVAT or SLVAT under a bonus-malus criterion may be adopted for the VAT chain frauds with international origin and for the purchases from missing traders. On the other hand, if one adopts the above seen constraints to the measures to combat the VAT frauds under DVAT, none of the general solutions suggested, based on the origin principle, as LOVAT, VIVAT or CVAT, may pass the test. Indeed they create distortion either against the intra community deliveries of goods internal to 49

On these themes, see Council of the European Union, Combating tax frauds, provisional version of 5 June 2007, Part I. Conventional measures suggest to introduce amendments in declaring intra Community supplies, with the aim of reducing time frames, to ensure more rapid sharing of such information among tax administrations; to improve confirmation messages and information on business identified for VAT purposes to operators active in intra-Community trade without hampering the risk analyses applied by member states.

23

the same firm or against the intra community deliveries among firms. Furthermore because exports to non EU States are not subject to the origin principle, these exports shall be favoured against those in the intra community trade. This discrimination shall be particularly important in the States at the borders of the EU, whose exporters have the incentive to trade more with their non EU neighbour states than with their EU neighbours. And both VIVAT and CVAT, which, to other respects, appear an improvement on LOVAT as devised by EUC 1996 proposal, discriminate in favour of B to B transactions and against firms selling to final consumers, while unexpected discriminations may also arise pro or cons firms selling both to B and final consumers. Nor any VAT systems based on the origin principle can avoid, as for the intra community trade, the interruption of the VAT chain that arises from the fact that in the different Member States different revenue administration operate with different ID codes for their VAT taxpayers. One must renounce to search the optimal solution to this issue. Only second best solutions are available. A VAT system informed to the destination principle, with the taxation at the place of the importers, respects the constraints of the EU “one market”. In order to avoid the frauds that may accompany this retreat of the locus of intra community imports’ taxation, one needs an array of techniques of control, new administration costs and efforts and efficient international information cooperation. The alternative models based on the origin principle, as for the one market constraint give inferior results, while infringing the fiscal autonomy and fiscal responsibility principles of the Member States in the VAT area. In order to function well as a contrast to the intra community frauds and for the sharing the VAT revenue they need an even more efficient international information cooperation.

References Barham V., S.N. Poddar and J. Whalley (1987), “The Tax Treatment of Insurance under a consumption type Destination Basis VAT, National Tax Journal, XL, n.2 (June), 171-82 Bosch H. (2006), “Progetto di parere della Commissione per il controllo dei bilanci”, 30/3/2006, PA/6095761T,doc PE 371.852 v02-00. Cnossen, S. (1990), “Taxing Value Added: The OECD Experience,” International VAT Monitor 5 (May), 2–16. Cnossen, S. (1994). “Administrative and Compliance Costs of the VAT: A Review of Evidence,” Tax Notes 63, 1609–1626. Cnossen, S. (1998). “Global Trends and Issues in Value-Added Taxation,” International Tax and Public Finance 5, 399–428. Cnossen, S. (2001). “Tax Policy in the European Union. A Review of Issues and Options.” FinanzArchiv 58, 466–558. Commission of the European Communities (2006), Risk Management GuideFor Tax Administrations, European Commission's Taxation and Customs Union, Directorate General, Indirect Taxation and Tax

24

administration,Administrative cooperation FPG/11),Version 1.02 (February 2006)

and

fight

against

fiscal

fraud,

(FINANCIAL

CODE:

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Keen, M., and J. Mintz, (2004), “The Optimal Threshold for a Value-Added Tax,” Journal of Public Economics 88, pp. 559–76. Keen, M. and S. Smith. (1996). “The Future of Value-Added Tax in the European Union,” Economic Policy 23, 375–420. Keen, M. and S. Smith. (2000). “Viva VIVAT!” International Tax and Public Finance 7, 741–751. McLure, C. (2000). “Implementing Subnational VATs on Internal Trade: The Compensating VAT (CVAT),” International Tax and Public Finance 7, 723–40. Monatsbericht des BMF January 2006, quoted in European Court of Auditors (2007). Sinn, Gebauer and Parsche (2004), “The Ifo Institute’s Model for Reducing VAT Fraud: Payment First, Refund Later,” CESifo Forum 2. Varsano, R. (2000), “Subnational Taxation and Treatment of Interstate Trade in Brazil: Problems and a Proposed Solution,” In Decentralization and Accountability of the Public Sector, ed. by S. J. Burki et al., Proceedings of the Annual Bank Conference on Development in Latin America and the Caribbean, (Washington: The World Bank), 339–355. Zee, H.H. (2005), “A New Approach to Taxing Financial Intermediation Services under a Value Added Tax”, National Tax Journal LVIII, n.1,(March), 77-92.

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Pubblicato in proprio Dipartimento di Economia Pubblica Facoltà di Economia Università degli Studi di Roma “La Sapienza” Via del Castro Laurenziano 9 – 00161 Roma

ISSN 1974-2940

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Working Paper del Dipartimento di Economia Pubblica Università degli studi di Roma “La Sapienza” Via del Castro Laurenziano 9 – 00161 Roma

COMITATO SCIENTIFICO Eleonora Cavallaro Giuseppe Croce Debora Di Gioacchino Maurizio Franzini Luisa Giuriato Domenico Mario Nuti Antonio Pedone Enrico Saltari Annamaria Simonazzi

I Working Paper vengono pubblicati per favorire la tempestiva divulgazione, in forma provvisoria o definitiva, dei risultati delle ricerche sulla teoria e la politica economica. La pubblicazione dei lavori è soggetta all’approvazione del Comitato Scientifico, sentito il parere di un referee. I Working Paper del Dipartimento di Economia Pubblica ottemperano agli obblighi previsti dall’art. 1 del D.L.: 31.8.45 n. 660 e dal Decreto del Presidente della Repubblica 3 maggio 2006 n.252, art.37.

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