Going Round In Circles

First published in The Tax Journal, Issue 877, 19 March 2007

It has been some four years since the first article on Missing Trader Intra- Community (MTIC) VAT fraud appeared in The Tax Journal (Issue 690, 28 April 2003). The jurisprudence on the subject has, over the past few years, spawned a growing body of case law, including no fewer than three European Court of Justice (ECJ) judgments. However, the case law still leaves much to be revealed about the applicable principles in this area. That is not surprising, since much judicial effort (in the UK) has related to deciding not to decide MTIC or carousel fraud-related cases on their merits. It would be much better for all concerned if the litigation were permitted to go ahead as rapidly and as thoroughly as possible straight away, rather than prolonging the current period of 'phoney war', during which the innocent are damaged by not receiving their EU law rights to immediate input tax refund, while the guilty escape exposure in the rigours of the courtroom. Justice delayed is justice denied.

Background

In the broadest terms, MTIC or carousel fraud occurs when a VAT-registered trader in one EU Member State acquires goods at zero-rated prices from a trader in another Member State and on-sells them within his own country at standard-rated prices before disappearing without accounting for the acquisition and sales VAT to the tax authorities. The goods sometimes change hands domestically a number of times until they are finally exported at zero-rated prices by another VAT-registered trader, who reclaims the input tax he suffers. The goods could end up being re-circulated, hence the practice being referred to as carousel fraud. There is a more complex version of the fraud involving 'contra' trading, where parallel supply chains relating to different consignments are set up, with VAT only being accounted for on one of the chains.

These are, however, only statements of the broadest kind. It is the precise detail of the fraud or frauds in the case of each chain that is of paramount importance, both factually and legally. For example, is one dealing with a 'missing' trader or merely a 'defaulting' trader somewhere else in the chain? If defaulting, why has that trader defaulted? What precise kind of chain is it - for example, is it a closed carousel, where goods allegedly circulate round and round, or a looser, more fragmented situation? How do the steps in the chain interact, objectively speaking? In our opinion, the cases have too often taken a broad-brush approach to the actual detail. Too easily has it been somehow assumed that if there is fraud - or indeed mere non-payment of tax - somewhere in the chain, the chain itself is 'tainted'. The use of labels such as 'brokers' and 'buffers' have not helped, since they imply that the chain is a single unit, with parties playing pre-arranged roles.

Although it has now been confirmed that tainting does not deprive any of the activities in the chain of their status as economic activities, there is a danger that mere knowledge (actual or constructive) of problems elsewhere in the chain will be treated as an equivalent. This would be wrong. If a trader buys a computer from a shop whose owner says he is going bust tomorrow, and wants to sell cheap today, should the buyer (i) not make the purchase and/or (ii) not reclaim his input tax, because he knows that HMRC might not get all the output tax in the ensuing liquidation? What of the situation where the shop is solvent but says it can offer a good price because it has bought stock cheaply from a trader on the verge of collapse (or who had collapsed) - is the shop's customer precluded from buying or claiming his input tax because he has reason to believe that others in the chain will not fully discharge their fiscal liabilities? Does he have to ask if the collapse was an honest collapse or a dishonest one, or a combination? How precisely does that alter the trader's rights under Article 17 of the Sixth Directive (now Articles 167, 173, 176 and 177 of Directive 2006/112/EC, which entered into force on 1 January 2007 - see Article 413 thereof)? These issues lie at the core of the coming debate concerning 'extended verification', though they have yet to be brought into the open.

Extended Verifications By HMRC

The claims of a large number of taxpayers for the repayment of input tax have been effectively withheld by HMRC pending the completion of an 'extended verification' exercise in order to ascertain the extent to which (if any) the relevant claim has been 'tainted' by MTIC fraud.

However, this process often takes many months and occasionally in excess of a year, as the investigations typically cover the entire supply chain to which the taxpayer is connected and often include enquiries directed abroad. This places a large number of those taxpayers affected in a precarious financial position and some of them have even been forced to cease trading as a result. Such a measure would...