Combatting the scourge of ‘VAT Carousel’ fraud

By Jérôme Bryssinck – Head of Government Solutions at Quantexa

The collection of Value Added Tax (VAT) represents an integral contribution to the budget of EU states. However, for national tax agencies, the battle to ensure that individuals and companies pay their fair share remains ongoing. A recent study revealed the enormity of this task, with research showing a gap of £131 billion (€147 billion) between the VAT that should have been paid, and what was actually collected.

There are several reasons for the disparity. Some of these, such as accounting errors, knowledge deficits or differences in interpretation are relatively benign in nature. However, there are also a number of actors who deliberately exploit the regulations around VAT to defraud the system.

Missing Trader Intra Community (MTIC) fraud – also commonly referred to as ‘VAT carousel’ fraud – takes advantage of the EU’s laws around VAT and has blighted the continent for some time now. While its true scale is unknown, most reasonable estimates put its total cost at anywhere from £17 billion (€20 billion) to more than £89 billion (€100 billion) annually. Even though VAT carousel’s do not defraud individuals of their own personal funds – this doesn’t mean that the general public is unaffected. Missing tax revenue means less to spend on important public services like schooling and public health, reducing their effectiveness in delivery. It also increases the tax obligations of honest people.

VAT Carousels: What do they look like? How do they work?

Throughout its existence, the EU has sought to minimise barriers to trade, making inter-state commerce as frictionless as possible. Indeed, today it’s incredibly easy for traders to export to other organisations inside the bloc. Unfortunately, this lack of obstacles hasn’t gone unnoticed by fraudsters either.

VAT Carousel’s take advantage of EU regulations around cross border trade. VAT is waived on intra-community transactions – this means that if an organisation chose to import a good from a company based in another part of an EU, then they would not be obliged to pay VAT.

As such, to create a carousel, criminal groups will begin by establishing a company (referred to hereon out as Company A). Company A will then import goods from a company in the EU (Company B). As Company A has bought goods from another EU based company (Company B), no VAT is paid. Next, Company A will then sell these goods on, this time to an organisation based in the same country (Company C) as Company A. Company C could be completely legitimate, or another company controlled by the fraudsters. As this transaction was conducted within the domestic market, VAT will be included in the sale price of the goods. Company A is then obligated to inform the relevant tax authority that VAT was included in the sale price of the goods. It should then pass the VAT on. However, Company A then disappears, withholding the VAT. The goods will then be passed through several different organisations – with this being done with the intention of obfuscating any investigation, putting a buffer between a company and the goods. In a Carousel, the final company in the chain (Company D) will then re-export the goods to another EU member state – which in many cases will be the original company that exported the goods (Company B). Company D will then reclaim the VAT, while Company B will re-use these same goods in another carousel scheme, hence the name.

Tackling VAT Carousels

VAT carousels can be incredibly difficult to combat. The sheer enormity of cross border trade which takes place in the EU complicates the job of an investigator. With billions of euros in goods and services being exchanged daily, determining what is legitimate from that of nefarious origin is nearly impossible to do with absolute certainty.

Further muddling the matter is the coordination required for effective prevention. Due to the nature of the crime, it’s necessary for different member states to co-operate. However, the data necessary for investigation and prosecution will often be stored in a number of differing and mismatched forms, held by various bodies, distributed across the length and the breadth of the continent.

Luckily, there has been some movement towards more effective methods of tackling the fraud. VAT fraud is one of the EU’s nine priority crime areas, and Europol’s Analysis Project MTIC was established with the sole intention of battling the organised crime groups often responsible for VAT carousel schemes. Furthermore, through implementing the Transactional Network Analysis system – a pan-continental risk analysis system – the EU has made great strides towards modernising and harmonising the VAT system, making it less vulnerable to fraudulent activity. However, more can be done.

Leveraging technology to create better defences

Technological development should enable tax authorities to become more proactive, and as such more effective in their combat of VAT fraud.

To ensure that this prediction comes to fruition, we need to improve our protocols for sharing and analysing data at the continental data. Data must be held in a uniform format, and states should look to create a central database where information can be accessed by any relevant body quickly and easily.

We can then apply data analytics technology to this information to provide wider context behind organisations and the transactions they engage in. For example, technology would be able to alert an investigator to a company with an annual turnover of €100K that was placing an order for €2 million worth of goods, as such an order would be suspicious. Machine learning technology could then be used to generate algorithmic risk models, which would then be deployed to better identify suspect companies. This could’ve formerly taken a human investigator hundreds of hours to compile, and as such, the efficiency of investigations will be far improved.

Member states should also seek to collect VAT receipts in a standard that is machine readable. Not only will this help with the issue of incompatible data formats, it will also help to place tax authorities in a position wherein domestic and external data can be combined to provide context.

The Road Ahead

It can be argued that the EU has historically struggled with fraudulent activity. Criminal actors had become wealthy by exploiting the same rules that have allowed trade to flow freely. To ever truly tackle VAT fraud, we need to see a greater use of technology, allowing for investigations to be undertaken more efficiently. We must also encourage greater cooperation at a pan-European level, as this will prevent cases from going cold when goods are moved out of a country. Only through this thorough approach will we be able to see the bigger picture required to combat fraud.