Select Committee on Economic Affairs Third Report


CHAPTER 5: VALUE ADDED TAX

ANTI-ABUSE PROVISIONS, CLAUSES 17 AND 18

CONTEXT

  5.1  The Explanatory Notes to both clauses state that they are "intended to help tackle serious revenue losses from fraud and evasion in particular Missing Trader Intra-Community VAT fraud". The Notes put a figure on the total cost of the fraud to the UK of "between £1.7-£2.75 billion in 2001/02"[17]. The "Missing Trader" in question is the person in a supply chain who contrives fraudulently to retain VAT which he has charged to his customer, by placing himself beyond the reach of HM Customs and Excise (HMCE).

  5.2  Securing the VAT that would otherwise be lost in this way is the objective of Clauses 17 and 18. Clause 17 requires the provision of security from a trader, who makes a claim for input tax, while being in a supply chain, "whose operation places the revenue at risk"[18]. Clause 18 passes the liability to account for the VAT to another trader in the chain by imposing a "joint and several liability for the payment" on both supplier and recipient.[19].

  5.3  Our witnesses from the private sector were in no position to question the official estimate placed on the size of the tax loss to the UK, although a measure of surprise at the sheer scale claimed was expressed (QQ 62 & 388). There was general agreement that the mischief must be significant, on a European Community-wide scale, and that robust counter-measures to tackle it would be fully justified[20]. Witnesses did, however, express considerable apprehension that, despite the safeguards proposed, there was some risk of legitimate traders being caught by the measures (QQ 348, 135 & 223).[21]

  5.4  Ivan Rogers, HM Treasury, confirmed that this was by far the biggest single fraud confronting tax authorities at the present time. It was pan-European in scope, sector-specific, and being practised by highly sophisticated criminals (Q 738). Mike Wells (HMCE) gave some illustrative examples before explaining that the fraud in question manifests itself in two broad categories. The first he called the "simple acquisition" fraud, where a trader imports goods VAT-free from another EU state, sells on in the UK, charging VAT, and then "goes missing" without accounting for the VAT charged. The second, the so-called "carousel" fraud, is more complicated, because the same goods are passed from hand to hand in a chain of companies. HMCE had encountered as many as 12 in a single supply chain, of which eight were "missers", while four companies known as "buffers" completed VAT returns to give a veneer of respectability (Q 739). Mike Wells went on to set the problem in the context of the HMCE efforts to contain it in a recent illustrative year—2001/2002. 4,870 businesses had been visited to be screened; 1,128 suspect registrations had been identified and VAT registration had been refused; a further 463 "missing traders" who had slipped through the net were subsequently identified and their VAT registration had been cancelled; and £629 million worth of assessments had been issued. Such robust activity to clean up the trade had been welcomed by many businesses in the sector (Q 742).

CLAUSE 17

  5.5  Budget Note CE 14/03, in its general description of the measure, said "The aim of the new proposal is to tackle serious cases of VAT evasion where several businesses act together to attack the tax system. In certain types of fraud the business with the greatest tax liability will often quickly disappear or become insolvent, resulting in serious revenue loss. The new proposals will allow for a proportionate security requirement from each business that together protects the total tax at risk in a VAT supply chain."[22]. As regards safeguards to protect innocent parties, the Note added that businesses covered by the provision will always be warned in advance of any requirement to provide security[23], and that there would be an explicit right of appeal to the VAT and Duties Tribunal covering the requirement to provide security as a condition of making a repayment.[24]

  5.6  Witnesses from bodies representative of professional interests argued that the measure was not proportionate to the mischief it was intended to prevent (QQ 566 & 576).[25] They made the following points:

    (a)  that, as presently drafted, the Clause was not targeted sufficiently narrowly on the stated mischief (QQ 512, 520, 570 & 572)[26];

    (b)  that the draft did not include a statutory requirement to give a warning[27];

    (c)  that, in any case, to give a warning could breach the Customs & Excise duty of confidentiality towards the suspected evader[28];

    (d)  there was also concern at the extra cost of providing a guarantee for a legitimate business that was simply concerned to protect its cash flow (Q 136);

    (e)  that the provision ought to be made to bite only in the extreme situation (Q 223); and

    (f)  if you are a trader, and it should come to your attention that another trader in a supply chain of which you are a part, has been "warned" about you, there is no provision at present for any right of redress (Q 288).[29].

  5.7  We asked Mike Wells about the steps a legitimate trader might reasonably take in order to satisfy himself (and subsequently, if necessary, HMCE, upon enquiry) that he was not knowingly involving himself with an "artificial" chain. He insisted that it was essentially a matter of displaying normal commercial prudence. For example, mobile phones have a unique reference identifier; it would not be normal practice for a legitimate trader to ignore these identifiers in stock records. It was also essential for a trader to demonstrate that he had made reasonable enquiries to satisfy himself about the status of his supplier, having regard to the nature and sheer size of the transaction. He instanced a business conducting sales of millions of pounds worth of computer chips from a "bungalow in Buckinghamshire". He played down the suggestion that, in these particular sectors, volatility of prices meant that it was difficult for a trader to recognise when a deal offered to him was "absurdly good". He considered that traders dealing on the scale at issue were certain to have a pretty clear idea of the Open Market Value of any given quantity of stock. He concluded: "In the final reckoning, however, if a business has taken all reasonable steps, then we have committed, indeed the Economic Secretary committed in the House of Commons, to ensure that we will not apply the measure where we are satisfied that the business has undertaken all reasonable checks to establish that it is not party to this fraud" (Q 742).

  5.8  We went on to ask Mike Wells about the way in which the legislative safeguards provided in the Clause would work. He stressed that the power to require security was not new under the VAT provisions; but what was novel about the extension of those powers in Clause 17 was an explicit right of appeal to the VAT and Duties Tribunal. He acknowledged that the right of appeal was exercisable only after the event, in the sense that the requirement to provide security (after warning) came first (QQ 764-765). He also placed stress on the novelty in this area of the public commitment to give a warning before requiring security. This was a deliberate step to balance the strength of the power with a safeguard to protect the legitimate business. He said: "Clearly, in committing to giving a warning at times we are giving rather more advantage to the fraudster than we would do if we were not giving a warning, but that is a trade-off in that case to provide a degree of safeguard to the legitimate businesses who have that opportunity to change whatever element of their practice it is that is otherwise in jeopardy of being affected by the measure" (Q 769).

  5.9  We have taken note of the scale and nature of the problem of missing trader fraud, and are convinced that the two legislative steps that are proposed in Clause 17 and Clause 18 are necessary to underpin the efforts of HMCE to contain it. However, we have heard from a succession of witnesses about their perception that, as presently drafted, the proposed legislation is lacking in the protection it affords to legitimate traders who may find themselves caught up in circumstances where HMCE seek to apply it in practice. We pressed our witnesses to come up with suggestions of measures that would redress that balance, while still permitting the proposed powers to be used effectively. However, with the exception of a suggestion in the supplementary evidence from the ICAEW (see paragraph 4.10), the response was not very productive. We took note of the strength of the undertaking by HMCE, reinforced by the Economic Secretary to the Treasury[30], that they would not apply the measure where they were satisfied that a business had undertaken all reasonable checks to establish that it was not a party to this fraud.

  5.10  With reference to the self-denying undertaking by HMCE, we note that the necessary degree of satisfaction on the part of the Department that all reasonable checks have been applied by a legitimate trader is not subject to any external review. Indeed, under the normal powers of delegation of the Commissioners of Customs and Excise, that discretion could rest with the investigating officer. We have therefore concluded that in the Clause, as drafted, the protection for a legitimate traders can be said to be deficient in that their access on appeal to the VAT and Duties Tribunal arises only after HMCE have applied their new power to require security, albeit following a warning. By this stage, the negative economic consequences for their business could already be significant. We considered that a part of the solution could lie in a suggestion made by the ICAEW[31] that, before taking steps to require security under Clause 17, HMCE should be obliged to seek leave from a Tribunal Chairman.

  5.11  We recommend that consideration be given to creating an enhanced statutory safeguard for legitimate traders, which would ensure that the conclusions related to Clause 17 arrived at by the investigating officer are reviewed at Board level within the Department and by an external judicial authority before the power to require security is exercised. This two-stage review would precede the issue of the preliminary warning letter contemplated as an essential element of Departmental practice in operating the new power. Under the procedure which we envisage, the application, which should be approved by the Commissioners of Customs and Excise themselves, without power of delegation, should be on an ex parte basis. Before giving leave, the Chairman of the VAT and Duties Tribunal would have to be convinced by the HMCE case against the trader that the business was involved or complicit in the alleged fraud.

CLAUSE 18

  5.12  Budget Note CE 15/03, in its general description of the measure, explained the effect as follows: "Where a business receives a supply of specified goods or services in circumstances where it knew or had reasonable grounds to suspect that VAT on those goods or services would go unpaid, it would be held liable for the tax due in the event of a default by the supplier"[32]. On introduction, the measure would be restricted to certain specified goods: telephones, parts and accessories, and computer equipment, parts accessories and software[33]. However, as drafted there is power to change, by Treasury Order, the designated goods or services to include different goods or services[34]. As regards safeguards to protect innocent traders, the Note states "A statement of practice provides details of the measure, explains what defences are available and provides guidance on steps that businesses can take to reduce the risk of unwittingly purchasing goods in an artificial supply chain"[35].

  5.13  Our witnesses from the private sector expressed their misgivings that the provision was so wide-ranging that it might catch ordinary commercial transactions (QQ 50, 287 & 359). A particular concern was focussed on the requirement, under subparagraph 2(b) of new section 77A of Part 4 of the Value Added Tax Act 1994 (c.23): "at the time of supply the person knew or had reasonable grounds to suspect that some or all of the VAT payable would go unpaid". In the view of our witnesses, a wholly innocent trader might find himself caught up in a supply chain, which, with hindsight, falls within the Customs & Excise term of "artificial", but about which he could not at the time of the transaction, have any knowledge (Q136). One witness put the problem to us succinctly: "Is it right that a trader should be liable for the VAT of someone else in the supply chain of whose existence he is not even aware?"[36]. John Whiting, PricewaterhouseCoopers and Chartered Institute of Taxation, suggested that requiring a trader to go "further back down the trail and forward, because the way the provision is drafted is as these goods move, that seems to us too much." (Q 223)

  5.14  Given that we found universal acceptance of the need to legislate to tackle the perceived fraud, we pressed our witnesses to come up with their own suggestions for refining the targeting of the measure, and improving the safeguards for the innocent. Several witnesses proposed that one of the various versions of the so-called "reverse charge on supply" approach (otherwise known as a "self-supply charge") should be adopted. Under this proposal, when making a purchase of a VAT-able supply, the purchaser should pay the ex-VAT price to the supplier, and himself account directly to Customs & Excise for the VAT due. (In passing, they noted that had there been any consultation exercise before the measure was published in the Bill, they would have taken the opportunity to urge such an approach.) One precedent of this type, dating from the 1980's and quoted by more than one witness is that operating in the market for gold (QQ 156, 236, 276, 372).[37]. Two other suggested variants were a system comparable to that adopted in respect of imported services from overseas (Q 159)[38], and the "'Black Box' or terminal markets system", which was described to us as applying within the terminal markets in the City, in particular, the Metal Exchange. No VAT is said to change hands where a transaction is between two members of the same exchange. VAT is only charged when a metal is supplied to somebody who is outside the Exchange (Q 160).[39]

  5.15  We put the "reverse charge on supply" alternative to our witnesses from HMCE. They told us that there were three arguments against its adoption, which together they found compelling. First, it would have to apply across the whole industry sector. They claimed that this was unjustified because the domestic trade was far less affected than the import-export trade: High Street retailers, for example, are not affected by this type of fraud. Second, as a practical matter, HMCE were not convinced that a "reverse charge on supply" arrangement would be particularly effective at combating the type of fraud being targeted: it would simply push the fraud down to the far end of the chain. Third, to introduce such a provision would involve first seeking a derogation from the European Sixth VAT Directive (Q 767).

  5.16  We accept, in the light of the evidence of officials, that none of the variants of the "reverse charge on supply" would work in the particular markets at which Clause 18 is aimed. We recognise that these markets are not "closed" and amenable to the tight degree of control that is available in the specialised markets such as gold and the metal exchange where such schemes have been adopted.

  5.17  Turning to other suggestions for improved safeguards by means of narrower targeting, one witness contrasted the Clause 18 approach unfavourably with the Netherlands counter-measures in respect of the missing trader problem, adopted in 1995. He considered that, following the Netherlands approach, the trigger for action under Clause 18 should be explicitly the risk of loss of VAT through fraud (thus excluding bankruptcy or insolvency) (QQ 288 & 354). Another witness suggested that the present Clause adopted a "scatter gun" approach, treating in the same way someone who (a) was himself committing the fraud, (b) was actively helping in committing the fraud, (c) knew that the fraud was going on, but just kept quiet and allowed it to happen, and (d) had no idea that the fraud had happened. The proper target should be the person who was aware of what was going on (QQ 368-370).[40]

  5.18  Tony Walker told us that HMCE had looked closely at other countries' efforts to legislate to tackle missing trader fraud, including in particular the Netherlands and Germany, and had sought to draw on their practical experience. Their respective laws had only become effective towards the end of 2002, so it was still too early to tell how successful the measures had been. He added that the draft UK legislation very closely mirrored the Dutch legislation (Q 751).

  5.19  Reverting to the issue of guidance to help protect legitimate business, Mike Wells confirmed that HMCE had received representations in the course of consultation on their draft guidance document concerning genuine business failures (the issue of insolvency). They planned to include further guidance in the proposed Statement of Practice about the protection for a legitimate trader, who could not reasonably be aware of the insolvency of another trader in the chain. Several important changes had already emerged as a result of consultation and the guidance note would be fuller, in the light of feedback received (Q 770). Tony Walker HMCE, filled in more details for us about the programme of road shows for the industry sectors and their professional advisers which had not only taken place as part of the consultation exercise, but would continue. (Q 772).

  5.20  We recognise the considerable educational effort that is being undertaken by HMCE to provide help and guidance for legitimate traders, in order not to find themselves through inadvertence, becoming involved in an "artificial" supply chain. However, we still have some misgivings that, as in the case of Clause 17 (see paragraph 5.10) the protection afforded to the legitimate trader by challenging the step of being made jointly and severally liable for the unpaid net tax in a supply chain only after the event would be insufficient. We acknowledge that the procedure begins with a "Notification Letter".[41] The trader then has 21 days in which to demonstrate to HMCE a legitimate reason. If he or she fails to do so, at the end of that period a Demand Notice will be issued for the unpaid net tax. But we still see the need to enhance the protection for a legitimate trader from the burden of being faced with a "Notification Letter" in the first place. The detailed arguments that we advanced at paragraph 5.10 in respect of enhanced statutory protection for the legitimate trader apply with equal force in the case of Clause 18.

  5.21  We recommend that consideration be given to providing that, before taking steps to hold a trader liable under the joint and several liability provisions of Clause 18, HMCE should be obliged to seek leave from a Chairman of the VAT and Duties Tribunal. The application, which should be approved by the Commissioners of Customs and Excise themselves, without power of delegation, should be on an ex parte basis. Before giving leave, the Tribunal Chairman would have to be convinced by the HMCE case against the trader that the business was involved or complicit in the alleged fraud.

  5.22  Our witnesses welcomed the consultative document "VAT Strategy: Joint & several liability Consultation on reasonable checks" Customs & Excise, April 2003. There was a degree of consensus that the list of questions set out in Appendix 2 "to demonstrate reasonable steps taken to ensure the integrity of supplies and supplier", was appropriate, although Dennis Knowles suggested that it would remove a great deal of anxiety if Customs & Excise accepted that a trader who had correctly carried out proper risk management procedures would not be caught (Q 59). In addition, some concern was expressed about what paperwork would need to be kept so as to demonstrate to Customs & Excise that such steps had indeed been taken (QQ 151-155).

  5.23  A more general concern was the principle of being obliged to rely on the Customs & Excise interpretation of their statement of practice for protection (Q 59).[42] Moreover, while a trader may rely on a statement for the purposes of a current transaction, there is no procedure under which any change in the statement as it applies to future transactions can be challenged. Finally, some witnesses expressed concern at the power taken to vary the categories of goods or services specified by Treasury Order. As one witness put it, there could be a "creeping widening" of the scope, without the degree of scrutiny that primary legislation would receive (QQ 365, 577 & 619).

  5.24  We are conscious that the public consultation that was launched with publication of the HMCE draft document in April 2003 was still under way as this Report was being prepared. It ended on 10 June 2003, and HMCE told us that they hoped to publish as soon as possible thereafter (Q 770). We assume that the points that have been raised with us will have been put directly to HMCE. If so, we hope that they will receive appropriate consideration. In that hope, we confine ourselves to the following further comment.

  5.25  Our view is that concerns expressed to us by witnesses about the creeping widening of the categories of goods or services specified by Treasury Order should be much allayed if the system of enhanced safeguards for the legitimate trader, which we have commended for consideration above, is adopted.


17   E.N. Clause 17 paragraph 18, E.N Clause 18 paragraph 16, and the Red Book shows the yield from the changes being made this year at £m225 [Budget 2003 HC 500, Table A.1 Protecting Tax Revenues at line 26 VAT anti-fraud measures]. Back

18   E.N Clause 17 paragraph 2. Back

19   E.N Clause 18 paragraph 1. Back

20   See evidence by: Institute of Chartered Accountants in England & Wales; Ernst & Young; Chartered Institute of Taxation; and The Law Society (Volume II, HL Paper 121-II). Back

21   See evidence by: Institute of Chartered Accountants in England & Wales; PricewaterhouseCoopers; Institute of Indirect Taxation; Chartered Institute of Taxation; and The Tax Law Committee of the Law Society of Scotland (Volume II, HL Paper 121-II). Back

22   Budget Note C.E 14/03 paragraphs 3 and 4. Back

23   Budget Note C.E 14/03 paragraph 1. Back

24   Budget Note C.E 14/03 para 4. Back

25   See evidence by: PricewaterhouseCoopers; Institute of Chartered Accountants in England & Wales; Institute of Indirect Taxation; and Chartered Institute of Taxation (Volume II, HL Paper 121-II).  Back

26   See evidence by: Institute of Chartered Accountants in England & Wales; and The Tax Law Committee of The Law Society of Scotland (Volume II, HL Paper 121-II). Back

27   See evidence by Institute of Chartered Accountants in England & Wales (Volume II, HL Paper 121-II). Back

28   See evidence by Institute of Chartered Accountants in England & Wales; and Institute of Indirect Taxation, (Volume II, HL Paper 121-II). Back

29   See evidence by Institute of Indirect Taxation (Volume II, HL Paper 121-II). Back

30   Commons Hansard, Standing Committee B, 15 May 2003, col.64. Back

31   See evidence by Institute of Chartered Accountants in England and Wales (Volume II, HL Paper 121-II).. Back

32   Budget Note CE 15/03 paragraph 4. Back

33   Budget Note CE 15/03 paragraph 2. Back

34   Explanatory Note Clause 18 paragraph 11, describing new subsection 77A(9). Back

35   Budget Note CE 15/03 paragraph 5. Back

36   See evidence by Institute of Indirect Taxation (Volume II, HL Paper 121-II). Back

37   See evidence by the Tax Faculty of the Institute of Chartered Accountants in England and Wales (Volume II, HL Paper 121-II). Back

38   See evidence by the Tax Faculty of the Institute of Chartered Accountants in England and Wales (Volume II, HL Paper 121-II). Back

39   See evidence by the Tax Faculty of the Institute of Chartered Accountants in England and Wales (Volume II, HL Paper 121-II). Back

40   See evidence by the Tax Faculty of the Institute of Chartered Accountants in England and Wales (Volume II, HL Paper 121-II). Back

41   HMCE "VAT Strategy: Joint & several liability, Consultation on reasonable checks", at page 12. Back

42   See evidence by the Tax Faculty of the Institute of Chartered Accountants in England and Wales (Volume II, HL Paper 121-II). Back


 
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