Tax Fraud, Evasion and Misclassification
Like any tax, the VAT is vulnerable to evasion and fraud. But its credit and refund mechanism does offer unique opportunities for abuse, and this has recently become an urgent concern in the European Union (EU). This section describes the main forms of noncompliance distinctive to a VAT. (Keen, Smith, VAT Fraud and Evasion, IMF 2007)
The above-mentioned paper describes thoroughly the way companies plan and execute tax fraud:
- Under-reported sales: A trader may report only a proportion of sales, falsifying records and accounts to match, or may make some sales transactions ‘off the books’ entirely.
- Failure to register: Small Business with relatively an income close to the given threshold to register for VAT. By opting not to register, such business save on output VAT, hence undercutting their competitor prices, On the other hand, they may deal with Ghost traders “wholly unknown to the revenue authorities” in order to be always under the authorities radars.
- Omission of self-deliveries: Goods or services produced by the business and consumed by the proprietor or employees, in principle taxable, may not be declared.
- Tax collected but not remitted: This may be possible either through false accounting or by fleeing the country before tax is paid.
- False claims for refund: This is the most obvious way to exploit the system. For example, 44 percent of all VAT fraud found in an investigation in the Netherlands took the form of false claims for tax paid at previous stages, this was done by presenting forged invoices for nonexistent or exaggerated purchases.
- Misrepresented purchases: items bought for private consumption may be misrepresented as business inputs, allowing the VAT to be recovered (and income tax liability reduced).
- Invoice Mills:Companies may be set up solely to generate invoices that allow the offender to recover an unpaid input VAT. Exploit the practical impossibility of cross-checking every invoice against evidence that earlier tax has been paid.
- Under-valuation: This fraud is usually committed within the import process. A resident agent requests the overseas supplier to generate an invoice for the imported goods with a far less value than what was agreed upon. The operation may have a dual saving effect on the resident trader as he will be able to cut back on the customs duties as well as the corresponding VAT levied by the Customs Authority.
- Misclassification: Misclassification is one of the major frauds within the VAT system. Studies suggest that this operation generally happens within the E-Commerce, but can happen within the usual marketplace.Simplified, the taxable persons manipulate their digital records to claim that the goods/services exchanged via an online transaction destined to a nonresident buyer, afterwards goods are sold in local grey market or services records can just be deleted.
- Carousel fraud: A special case exploiting the zero-rating of exports combined with the“Deferred payment” mechanism for collecting VAT on imported goods. Under the latter, adopted in the EU with the removal of fiscal frontier formalities in 1992,15 VAT on imports from another member state is collected not at the border but at the time of the next periodic return. In the simplest case, illustrated in Figure 1 and 2, carousel fraud works as follows:
“deferred payment” mechanism for collecting VAT on imported goods. Under the latter,
The Basic Carousel Fraud
- Company A exporting the goods froma non GCC member state to the UAEtherefore no VAT is involved.
- Company B: imports the goods and pays the related VAT through customs clearance, it then resells the items to Company C and levied the related VAT. Company B vanishes before submitting the output tax to the authorities.
- Company C may be a legitimate trader with no intention to defraud the authorities pays the input VAT and resells the goods to Company D.
- Company D pays the VAT levied by company C and then claims that the items are exported to a non GCC country and therefore no VAT should be levied. In reality, the goods were sold locally through the black market & Ghost traders.
As a recap, the financial chart will be as follows:
The outcome is just real categorical theft, instead of getting 250 AED as VAT, the Government has disbursed 100 (i.e. a loss of 350 in VAT income).