6 Different Types of VAT Fraud Schemes

VAT fraud presents a substantial challenge within the UK’s taxation ecosystem, as a range of intricate schemes exploit vulnerabilities inherent to the Value Added Tax structure.

These fraudulent activities not only undermine the government’s revenue collection endeavours but also create an uneven competitive landscape for legitimate businesses.

Common types of VAT evasion comprise not being registered for VAT, employing an incorrect VAT number, and requesting payments to be directed towards different individuals and/or addresses.

HMRC might employ accusations of fraud and the prospect of legal action as a tactic to induce individuals to admit guilt and commit to settling their liabilities.

Among the prevalent types of VAT fraud schemes in the UK, carousel fraud stands out as a particularly complex and disruptive mechanism. Also recognized as missing trader intra-community (MTIC) fraud, this scheme involves a chain of companies manipulating cross-border trade transactions to exploit the VAT refund system.

Another prevalent type is missing trader fraud, wherein a business deceitfully claims VAT refunds for goods it has never procured or imported. Additionally, false invoicing and invoice manipulation schemes entail the manipulation of transaction documents to inflate input tax claims or underreport output tax liabilities.

These deceptive stratagems underscore the urgency for stringent detection protocols, seamless collaboration between enterprises and tax authorities, and comprehensive preventive strategies to uphold the sanctity of the UK’s VAT system.

Examples of different types of VAT Fraud

There are many different potential types of VAT fraud. Some of the most common types include:

1. Carousel Fraud

Carousel fraud, also known as missing trader intra-community (MTIC) fraud, is a sophisticated form of VAT fraud that has posed significant challenges to the UK’s taxation system.

In this intricate scheme, a group of interconnected companies exploits the cross-border nature of intra-community trade to fraudulently claim VAT refunds from the government.

The essence of carousel fraud lies in the manipulation of high-value goods, often electronics or computer chips, across international borders in a circular manner.

Each participant in the scheme buys and sells the same goods multiple times, but only the initial purchase is legitimate, while subsequent transactions are designed to generate fraudulent VAT refund claims.

Example of Carousel Fraud: A Deceptive Trade Loop

Imagine Company A imports electronics from another EU country, legitimately paying VAT on the import. However, instead of selling the goods in the UK market, Company A sells them to Company B, also within the UK, without charging VAT. Company B then sells the same goods to Company C, which may be a shell company created solely for the purpose of this fraud, again without charging VAT.

This cycle continues with subsequent transactions, involving various companies, and each participant claims a VAT refund from the government for the VAT they paid initially.

However, the fraud becomes apparent when the goods are eventually exported back to the EU, making it a cross-border transaction, and the last company in the chain goes missing or becomes insolvent.

The government ends up paying out substantial VAT refunds without receiving the appropriate tax revenue, causing significant financial losses.

This complex web of transactions, often involving multiple jurisdictions and intermediaries, makes carousel fraud challenging to detect and combat effectively.

2. Missing Trader Fraud

Missing trader fraud is another prevalent type of VAT fraud that has plagued the UK’s taxation system. This deceptive scheme involves a business, typically referred to as the “missing trader,” fraudulently claiming a VAT refund on goods it supposedly purchased for resale.

However, in reality, the missing trader never actually acquires or imports the goods. The fraudster takes advantage of the fact that VAT is charged at each stage of the supply chain and the refund system for legitimate businesses, creating an opportunity to claim VAT refunds on fictitious transactions.

Example of Missing Trader Fraud: Fabricated Transactions

Let’s say Company X is engaged in missing trader fraud. It presents itself as a legitimate trader involved in the import and resale of high-value goods, such as electronic devices. Company X imports a batch of electronics from an EU country and pays the VAT upon importation.

However, instead of reselling the goods in the UK market, Company X orchestrates a series of fictitious transactions involving multiple intermediary companies. These intermediaries generate invoices that suggest the goods are being bought and sold, even though no actual goods change hands.

The final company in the chain claims a refund for the VAT paid upon import, effectively pocketing the VAT amount without having engaged in any legitimate business activity. Meanwhile, the initial VAT payment remains in the government’s hands, resulting in a significant loss of revenue.

Missing trader fraud exploits the complexity of supply chains and the inability to verify every transaction’s legitimacy in real time. Despite efforts by tax authorities to prevent such fraud, the constantly evolving nature of these schemes demands continuous vigilance and adaptive measures to protect the integrity of the VAT system.

3. Cash Fraud

Cash fraud is a deceptive strategy employed to avoid paying the appropriate Value Added Tax (VAT) by underreporting sales transactions.

In this scheme, businesses deliberately manipulate their records to reflect fewer sales than they actually conducted, resulting in lower VAT liabilities. This fraudulent practice allows them to retain a portion of the collected VAT instead of remitting it to the government.

Example of Cash Fraud: The Unrecorded Transactions

Imagine a restaurant owner, Restaurant A, engaging in cash fraud. During a given month, Restaurant A conducts a significant number of cash transactions, receiving payments from customers in cash. Instead of accurately recording all these transactions in their accounting system, the owner intentionally reports only a fraction of the actual sales as cash revenue.

This manipulation results in a lower reported turnover, leading to a reduced VAT liability. The unrecorded cash is then kept off the books, effectively evading VAT payments to the government.

Cash fraud is a concerning challenge for tax authorities as it operates on a concealed level, making detection difficult. By exploiting the anonymity of cash transactions, businesses engaging in this scheme compromise the integrity of the VAT system and undermine the government’s ability to collect legitimate tax revenue.

To counter such fraud, tax authorities often rely on audits, data analysis, and collaborations with financial institutions to identify discrepancies and ensure businesses are accurately reporting their transactions.

4. Online Fraud

Online VAT fraud is a form of financial deception that exploits the digital landscape to manipulate Value Added Tax (VAT) systems and evade legitimate tax payments.

This type of fraud capitalises on the anonymity and complexity of online transactions, creating challenges for tax authorities in detecting and preventing fraudulent activities.

In the realm of online VAT fraud, cybercriminals employ various techniques to manipulate digital platforms and transactions to their advantage.

Example of Online VAT Fraud: Carousel Fraud in the Digital Age

An example of online VAT fraud is the continuation of traditional carousel fraud in the digital realm. In this scenario, fraudulent companies create online marketplaces or e-commerce platforms to facilitate fictitious transactions involving high-value goods or digital products.

These transactions are designed to generate false VAT refund claims, exploiting the VAT refund system’s intricacies. These fraudulent businesses may also exploit cross-border transactions within the European Union, taking advantage of VAT exemption rules.

In the digital era, VAT fraud can become more complex due to the rapid exchange of goods and services across international borders. Tax authorities need to adapt their detection methods to identify suspicious online activities, collaborating with digital platforms, payment processors, and cybersecurity experts.

Combating online VAT fraud requires a combination of technological innovation, legal frameworks, and international cooperation to ensure that the digital marketplace remains a fair and secure environment for all participants.

5. Contra Fraud 

To obscure the detection of MTIC fraud, fraudsters often resort to complex strategies, one of which is the utilization of ‘contra trading’.

The term ‘contra trader’ pertains to a VAT-registered taxable entity within the UK that engages in two distinct transaction chains within the same VAT period. In this scenario, the output tax generated from one chain is deliberately designed to offset the input tax incurred in the other chain. These two transaction chains consist of:

1. Tax Loss Chains: In these instances, the taxable entity incurs input tax on purchases made within the UK and then proceeds to make zero-rated supplies of these goods to customers situated in other EU Member States or exports the goods to customers outside the EU.
2. Contra Chains: In this type of chain, the same taxable entity typically procures goods from another EU Member State and subsequently sells them within the UK. The entity acts as the acquirer, thereby generating an output tax liability due to the UK sale.

While tax loss chains usually lead back to a defaulter or sometimes another UK contra trader (referred to as a ‘double’ or ‘multiple’ contra scheme), there is typically no tax loss within the contra chains.

This is primarily because the contra trader functions as the acquirer and possesses input tax that can be offset against its output tax liability. This intricate system of transactions and offsets creates a convoluted trail that can make the detection of MTIC fraud more challenging for tax authorities.

6. Acquisition Fraud

Acquisition fraud is a deceptive practice that revolves around the procurement of goods or services from another European Community (EC) Member State and subsequent sale to an end consumer.

This type of fraud often involves deviating from the expected audit trail outlined in invoices. It typically implicates both a defaulter – a party failing to meet their tax obligations – and buffers – intermediate entities inserted to further complicate the detection process.

Here is an example that elucidates the mechanics of acquisition fraud:

Consider Company A, a VAT registered entity in the UK. It engages in purchasing goods from an entity situated in another EC Member State. Subsequently, Company A resells these goods to Company B, another VAT registered entity within the UK. However, Company A cunningly avoids declaring or settling its VAT liability to the tax authorities.

Company B then takes the purchased goods and sells them to the general public. In this stage, Company B is entitled to reclaim the VAT initially charged to it by Company A. At the same time, Company B rightfully declares the VAT it charges on the sale to the consumers.

This example illustrates how acquisition fraud exploits the complexity of cross-border transactions and the intricate interplay of VAT regulations between Member States. The fraudulent practices deliberately deviate from expected invoicing and reporting norms, making detection a challenging task for tax authorities.

Conclusion

In the realm of Value Added Tax (VAT), the UK has grappled with different types of VAT fraud, each presenting intricate and evolving fraudulent practices that undermine the integrity of its taxation system. From the complexity of carousel fraud, through the deception of missing trader fraud, to the manipulation of online platforms, these distinct fraudulent schemes have posed persistent challenges to both tax authorities and legitimate businesses.

As technology advances and global trade becomes more interconnected, the fight against different types of VAT fraud demands continuous adaptation and innovation in detection and prevention strategies. The consequences of engaging in these fraudulent activities are significant, encompassing not only substantial financial penalties but also potential criminal charges and reputational damage.

The UK’s legal framework empowers tax authorities to take decisive action against those involved in different types of VAT fraud, emphasizing the need for businesses to prioritize compliance and vigilance to ensure the robustness and fairness of the VAT system.