26 Jul Countering VAT fraud in the EU: Is there a reason to be hopeful in Germany?
Adam Abukari and Umut Turksen from the PROTAX partner, Centre for Financial and Corporate Integrity at Coventry University, provide in this working paper an insight on the impact of VAT fraud in Europe and measures to counteract it.
Value-added tax (VAT) was conned as the most straightforward type of tax that has ever been designed (Cnossen, 1990). VAT proponents make a persuasive claim that VAT is an effective instrument for generating revenue from taxes. Recent scholarship on VAT largely agrees with this proposition. VAT is the most popular indirect tax that rakes in millions of euros every year for the 28 European Union (EU) Member States (MS).
However, VAT fraud has, for years, posed a serious threat to the vitality of VAT in the EU and its MS (Feria, 2009; Ainsworth, 2015). VAT fraud has a number of forms including non-declaration and/or non-payment and fraudulently claiming of the right to deduct input tax, VAT carousel fraud or Missing Trader Intra-Community (MTIC) fraud as well as VAT fraud related to digital technology (Feria, 2009).
Every year, VAT carousel fraud is estimated to cost Germany between €5 billion to about €14 billion. The current VAT rate in Germany is mostly 19%. Although the VAT losses in Germany are higher than that of other EU MS, the challenge of VAT fraud carousels has been known to be an EU-wide issue, not only Germany’s. Each year, cross-border VAT fraud or MTIC is estimated at €50 billion (Lamensch and Ceci, 2018) as tax loss in the EU – Europol estimates this loss to be €60 billion. (Europol, ‘MTIC (Missing Trader Intra Community) Fraud’ < www.europol.europa.eu/crime-areas-and-trends/crime-areas/economic-crime/mtic-missing-trader-intra-community-fraud > accessed 24 July 2019.)
Germany has occupied a special space in the VAT fraud problem because it has the largest economy in the EU and correspondingly have high vulnerabilities and high rate of VAT fraud. VAT fraud in Germany has significant adverse consequences not only on the economy of Germany but also on the other EU MS. It is for this reason that serious attention must be paid to the VAT fraud situation in Germany.
The scale of VAT fraud in Germany
The case of Azizi and VAT carousel – sign of a weak tax system?
For just a short period, Samir Azizi had transformed himself as a teenager that traded in mobile phones to a kingpin or champion in VAT carousel on carbon dioxide (CO2) emissions’ permits (Ainsworth, 2015).
LEAs began investigating the case of Azizi since 2007, when a savings bank in Cologne raised a red flag on money laundering against Azizi based on suspicious €1.7 million inflows (Correctiv, 2019). He became a subject of significant interest to LEAs in Düsseldorf.
When he was arrested, he was operating about eleven companies which had not been registered in his own name. Instead of earning from mark-ups, he earned his wealth from VAT fraud Correctiv (2019). The structure of the fraud was that, merchandise was moved in circles from one country to the other where VAT was not paid. Instead, tax authorities were tricked into paying the fraudsters rebates/refunds they were never owed. The alleged offences for the extradition of Azizi from the USA to Germany consisted 89 criminal counts with MTIC fraud schemes amounting to a loss of €61,104,368 in VAT revenue to the German Treasury (Ainsworth, 2015). In its verdict, the German court passed €40 million (Correctiv, 2019) against Azizi’s crimes. While there were other estimates about exactly how much Azizi defrauded the treasury, one of them stating €110 million, it is clear that this amount was certainly in millions. The thing is, although the fraud system utilised by Azizi and his associates was complex especially when he moved into trading on carbon emission certificates on the EU emissions trading system (ETS) and acting as a ‘buffer’, it did not appear to need the services of high-class tax crime enablers (Correctiv, 2019). This is an indication of weaknesses of the tax regulatory mechanisms whereby many criminal minds can settle their minds on to exploit.
This case exposes the complex structure of the system of VAT fraud and how difficult it is for tax authorities and law enforcement agencies (LEAs) to effectively counteract it in Germany and the EU as a whole.
With the apparent financial loss caused by VAT fraud, one is left to wonder why the subject is not receiving the necessary attention by governments in the EU.
From the foregoing, the effectiveness of Germany’s political actors and LEAs in counteracting VAT fraud is questionable. However, EU legislation on VAT fraud can be said to be gaining traction in fighting the fraud menace. Germany is transposing the EU anti-tax fraud rules. The introduction of the marketplace law is instructive. All is not lost. If commitment to counteracting VAT fraud is escalated to ensure proactive investigation, cooperation, and enforcement on matters of VAT fraud, it will be a giant leap in the fight against tax crimes in Germany and the EU.
Through VAT fraud carousels, the same products are traded many times in a circular fashion. Both real and fake companies are used. By the time authorities take notice of the arrangements, the fake companies would have been long disappeared and it will be late in the day for investigators. It must be noted that the underlying infrastructure that enables the VAT fraud is ‘the complex system of tax settlements’ and different tax rates in the EU. The architecture of the EU VAT payment system is that VAT payment is only due for the final transaction (Feria, 2009; Frunza, 2013; Doesum, Kesteren and Norden, 2016). Therefore, trading companies are expected, by law, to invoice their buying customers with VAT and then transfer the VAT to the tax authority. Traders are then supposed to request from the tax authority that they are reimbursed for the input tax on purchase made on their supplies. There would not be much of a problem with this arrangement if there were effective coordination, monitoring and evaluation on the total VAT accrued and claims made by traders for reimbursement on supplies. However, the loophole is that the tax authority makes rebate payments without thorough confirmatory checks. The tax system also expects that trading companies will pay the due taxes to the tax authority within 90 days, even if not rigorously pursued (Correctiv, 2019).
In the EU VAT system, there are different VAT rates charged on goods and services in MS of the EU. This is on the back of free movements of goods and services across the EU. The tax arrangement is such that, traders in one country purchase goods and services in another country and then move back to their country of origin to sell to other traders in their country or other countries. This situation gives opportunity for fraudsters to trick tax authorities to appear as missing traders, and with the use of non-existing or ‘paper companies’, the fraudsters escape undetected or tracked by the tax authority and LEAs (Feria, 2009; Frunza, 2013; Doesum, Kesteren and Norden, 2016).
In a legal transaction, the distributor – as the last trader in the transaction chain that sells the products to another MS of the EU – is entitled to be reimbursed with the VAT that has been paid in Germany, if Germany is the recipient country of the goods (Correctiv, 2019). However, in a fraudulent transaction, middlemen are used to act as ‘buffers’ between the distributor and the ‘missing trader’ (HMRC v Livewire Telecom Ltd and HMRC v Olympia Technology Ltd  EWHC 15 (Ch)). This makes the transaction chain longer in a way that makes easy detection of the ‘missing trader’ and fraudulent activities a challenge for authorities. Similar instances were mentioned by LEAs in the focus groups run by PROTAX. The additional challenge is that both the ‘buffer and the missing trader’ are not required to have any bank account. This is because a huge chunk of the transaction is executed online. A technological tool more sophisticated than the technological platform of the fraudsters will have to be designed and constantly updated by the authorities. For example, the Dutch Tax Authority employs a ‘real-time’ reporting platform which makes financial analysis not only meaningful but also speedy should a formal investigation and evidence gathering are pursued.
So, Azizi had been in charge of companies that were used as buffers in the transaction chain (Ainsworth, 2015).
Big player with vulnerable disposition?
With this EU-level arrangement, MS are left to put in place appropriate measures to ward off the VAT fraudsters. Compared with other EU MS and given its status as the largest economy in Europe, Germany has not demonstrated adequate feat in countering VAT fraud. A number of reasons account for this claim including the following five key loopholes. Low public interest, inadequate political interest and inadequate, secrecy in the system, cooperation in the federal structure of Germany, and inadequate legal framework (PROTAX 2019).
There does not appear to be significant public interest in the tax crimes in general and VAT fraud in particular. This can be highlighted by the reactions of the public and media when tax scandals break out. It is also demonstrated by the public not making tax fraud a serious matter to attract significant political attention (Correctiv, 2019). This factor is linked to inadequate political interest and will to frontally counteract VAT fraud. Awareness of taxpayers about the magnitude of VAT fraud in the country appears to be limited. The government does not appear to have the appetite to stir the boat of public interest about knowing the scale of the tax fraud in Germany. Therefore, it may be what has accounted for the government’s reluctance to readily make available to the public data on VAT fraud. There are economic and financial forces that support the status quo (Correctiv, 2019). It, therefore, appears that the government of Germany is hesitant in taking up the fight with these powerful forces in the economy. It is when public interest in the seriousness of VAT fraud is heightened and agitations or advocacy in this regard is intensified will the government place seriousness of VAT fraud on the political radar.
Regarding the cooperation issues with federal structure of Germany, each of the country’s 16 states are clothed with the responsibility to levy VAT and investigate tax fraud. Under normal circumstance, the tax authorities and prosecutors in the 16 federal states should have well-established system for cooperation and exchange of information. In practice, however, this is not the case. They hardly cooperate effectively on matters of VAT fraud. In addition, the federal states cannot directly request from their counterparts in other MS of the EU to give them information on tax fraud issues. The arrangement is that federal states in Germany are expected to channel their requests through the central government and data protection officers of a number of agencies to acquire such information. This process is fraught with undue delays and can even take many months in order to receive relevant tax information.
Correctiv (2019) claims that Germany is one of the countries that is applying brakes or standing in the way of EU’s efforts to enhance criminal prosecutions. This is because, although MS of the EU currently exchange information on counteracting tax fraud through the Eurofisc platform, Germany has been reluctant participant on the Eurofisc’s Transaction Network Analysis (European Commission, 2017; UK Parliament, 2018; Correctiv, 2019). The argument put forward by Germany is that the Eurofisc system which affords a joint analysis of data of MS is likely to compromise its regime of secrecy which has been regarded as a national priority. But even though the joint data analytical system provided by Eurofisc can significantly help in countering tax fraud, this system has been evaluated as not very effective in enforcing the laws on tax fraud. To take this system a notch higher, the EU is establishing a prosecution agency (i.e. European Public Prosecutor’s Office) which, according to the European Commission, has been planned to take off by the end of 2020. This agency will leverage the exchange system provided by Eurofisc and other cooperative mechanisms in order to succeed. It is imperative Germany escalates its participation in all the exchange and cooperation mechanisms in the EU to effectively have firm grips of VAT fraud in the country.
All is not bleak
Germany has been active in complying with large part of EU VAT law. The foundation of the VAT law in the EU is established by the European Union law which lays down the principles and framework of taxation in the EU. The key legal instrument on VAT is the Council Directive 2006/112/EC which provides a framework for the common system of VAT in the EU. Directive 2006/112/EC is the first Directive on VAT that gives more specific rights and obligations. This Directive has been amended a number of times. The good news is that Germany has transposed Directive 2006/112/EC into its national law. Germany has therefore contributed to the largely harmonised nature of VAT legislation in the EU.
Germany is also part of cooperation mechanisms in Europe such as VAT Information Exchange System (VIES), and other platforms on cross-border information exchange such as submission and receipt of administrative enquiries. Germany is also part of Eurofisc, with limited participation (European Commission, 2017; KPMG, 2019), which was established under EU Regulation No 904/2010 on administrative cooperation and combating VAT fraud to help in cross-border information exchange to prevent and detect VAT fraud that criss-crosses borders of EU MS. The Eurofisc is the key exchange platform solely targeting VAT fraud. General and operational information on VAT fraud are processed by liaison officials from all EU MS – with support of non-EU MS such as Norway. Eurofisc has not only served as an early warning system but also it has helped to prevent and detect VAT fraud across the EU. The implementation of Eurofisc in Germany is done through the liaison official with the Federal Central Tax Office (BZSt) and the Länder’s responsible contact points. In fact, pursuant to Article 108 of the Basic Law (Grundgesetz), the Länder is charged with the responsibility to monitor and collect VAT in Germany (Federal Ministry of Finance, 2018). Accordingly, Germany shall act beyond being a mere observer on the Transaction Network Analysis of Eurofisc in order to effectively help in countering VAT fraud. Regional cooperation is important because VAT fraud has become a cross-border phenomenon.
Germany has continued to improve its internal measures on information exchange and cooperation between the Länder and the federal level. The Länder and the Federation conduct joint actions to counter VAT fraud so as to ensure that ‘tax revenues are safeguarded, fair taxation is guaranteed, and tax-compliant companies are protected against distortions of competition’. The Federation or Bund and the Länder particularly cooperate and exchange information on monitoring and detection of VAT fraud (Federal Ministry of Finance, 2018). Early and effective monitoring of VAT fraud is recognised as one of the key methods to effectively counteract VAT fraud in the EU and Germany. The actions by the Länder and the Federation to ensure early and effective monitoring include special audits, special IT procedures, strengthening of cooperation in tax administrations, automation of assessment of taxes, and marketplace legislation. In terms of special audits of VAT, these operations are conducted when business transactions are to begin and during the course of the transactions. Alongside this is unannounced or surprise visits to companies. A better transparency on beneficial ownership and accountability for unexplained wealth are also areas for development in Germany. These can help revenue authorities in getting the clarity of issues that have to be further examined (Federal Ministry of Finance, 2018).
In conclusion, it can be said that, at least on the legal framework front, Germany is moving in the right direction but she is doing this in an extremely slow fashion. More importantly, it ought to be acknowledged that in tandem with legal reforms, human, social and organisational factors need to be addressed if Germany wants to have a meaningful and effective change in countering VAT fraud. PROTAX partners have been gathering information about good practices in countering tax crimes across the EU. These will inform future direction of law enforcement and prosecution methods in tackling such illegal activities.
Ad van Doesum, Herman van Kesteren and Gert-Jan Van Norden, Fundamentals of EU VAT Law (Wolter Kluwer, 2016).
Correctiv, ‘Grand Theft Europe: A cross-border Investigation’ (7 May 2019) < https://correctiv.org/en/top-stories-en/2019/05/07/grand-theft-europe/ > accessed 20 June 2019.
European Commission, ‘European Public Prosecutor’s Office’ < https://ec.europa.eu/info/law/cross-border-cases/judicial-cooperation/networks-and-bodies-supporting-judicial-cooperation/european-public-prosecutors-office_en > accessed 24 June 2019.
European Commission, ‘Commission Staff Working Document Impact Assessment’ (Brussels, 30 November 2017 SWD (2017) 428 final)37 < http://data.consilium.europa.eu/doc/document/ST-14893-2017-ADD-1/en/pdf > accessed 13 June 2019.
Europol, ‘MTIC (Missing Trader Intra Community) Fraud’ < www.europol.europa.eu/crime-areas-and-trends/crime-areas/economic-crime/mtic-missing-trader-intra-community-fraud > accessed 24 July 2019.
Federal Ministry of Finance, ‘Combating VAT Fraud’ (Taxation, 13 November 2018) <www.bundesfinanzministerium.de/Content/EN/Standardartikel/Topics/Taxation/Articles/2018-11-08-combating-vat-fraud.html > accessed 13 June 2019.
KPMG, VAT Newsletter: Hot topics and issues in indirect taxation (June 2019) < https://assets.kpmg/content/dam/kpmg/de/pdf/Themen/2019/06/vat-newsletter-june-2019-kpmg-en.pdf > accessed 24 July 2019.
Marie Lamensch and Emanuele Ceci, VAT fraud: Economic impact, challenges and policy issues (Study Requested by the TAX3 Committee, European Parliament, 2018).
Marius-Christian Frunza, Fraud and Carbon Markets: The Carbon Connection (1st edn, Routledge 2013).
Richard Thompson Ainsworth, ‘VAT Fraud and Terrorist Funding -The Azizi Extradition Allegations Part I’ (29 June 2015) Boston University School of Law, Law and Economics Research Paper No. 15-24.
Rita de La Feria, The EU VAT System and the Internal Market (IBFD, 2009).
Sijbren Cnossen, ‘Taxing Value Added: The OECD Experience’ [May 1990] 5 International VAT Monitor 2-16.
Sijbren Cnossen, ‘Taxing Value Added: The OECD Experience’ [May 1990] 5 International VAT Monitor 2-16.
UK Parliament, VAT fraud: cooperation between tax administrations (Publications and Records, 3 April 2018) < https://publications.parliament.uk/pa/cm201719/cmselect/cmeuleg/301-xxii/30108.htm > accessed 13 June 2019.
Key Legal Instruments
Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax OJ L 347, 11.12.2006, p. 1–118.
Regulation No 904/2010 of 7 October 2010 on administrative cooperation and combating fraud in the field of value added tax (recast) on administrative cooperation and combating VAT fraud, L 268/1.
Fiscal Code of Germany in the version promulgated on 1 October 2002 (Federal Law Gazette [Bundesgesetzblatt] I p. 3866; 2003 I p. 61), last amended by Article 17 of the Act of 17 July 2017 (Federal Law Gazette I p. 2541).
Law on the prevention of VAT losses on trade in goods on the Internet and amending further tax regulations (2018).