Commission proposal on temporary measures for a consistent response to carousel fraud in certain sectors - briefing

29 September 2009
by eub2 -- last modified 29 September 2009

As a response to new and worrying fraud patterns reported by several EU Member States, the European Commission has adopted a proposal for an optional and temporary application of the reverse charge mechanism to supplies of certain goods and services, which will allow Member States to fight carousel fraud in a consistent manner across the European Union. The proposal notably covers greenhouse gas emission allowances that have been the object of VAT fraud during last summer. The proposal includes evaluation and reporting obligations for Member States which will allow a precise assessment of the efficiency of the measures.

What is the so called VAT reverse charge mechanism?

The reverse charge mechanism can only be applied to supplies to business clients. It allows the supplier of goods or services not to charge VAT to his customer. The supplier does not pay the VAT to the Treasury and it is up to the customer to do it. This customer can subsequently deduct this amount of self invoiced VAT, when the goods or services are fully used for business purposes.

Why does the Commission propose only a limited list and leaves Member States only a limited choice?

Contrary to what the effect would be of a generalised reverse charge system, the proposal is not intended to change the fundamental principles of the VAT system as regards the fractionated payment and remains therefore limited in scope, both as regards the number of goods/services and the duration of the application period. These limitations should allow a subsequent assessment of this type of measures which could be taken into account when considering new ways or means to combat VAT fraud.

The type of supplies to whom the scheme could apply is based on recent experience with missing trader fraud and on the recent developments during the summer of 2009 relating to VAT fraud on greenhouse gas emission allowances.

How does VAT carousel fraud work?

On internal supplies, a supplier charges VAT to his customer. His supplier pays this VAT to the Treasury. The customer, where it is a business, can reclaim this VAT from the Treasury. It is the final consumer who bears the VAT charge since he can not reclaim the VAT from the Treasury.

However, the rules are different for supplies to business clients in other Member States. The supplier does not charge VAT and the goods circulate VAT free.

The fraud mechanism works as follows. A company (B) acquires goods in another Member State without having to pay VAT to his supplier (A) . Subsequently it makes a domestic supply for which it charges VAT to his customer (C) . However, the company (B) does not pay the VAT to the Treasury and disappears. The customer (C) claims a refund of the VAT paid to the company (B) . Consequently, the financial loss is for the Treasury which has to refund VAT to the customer (C) which it never collected from the supplier (B) .

Subsequently, Company C may declare an exempt intra-community supply to Company (A) and, in its turn, (A) may make an exempt intra-community supply to (B) and the fraud pattern resumes, thus explaining the term "carousel fraud".

The main elements are the fact that there has been an intra-Community transaction and a trader charging VAT to his customer but not paying it to the Treasury and "going missing".

This is a very simplistic description of the fraud, which in reality is much more complex, involving a series of transactions with intermediary companies (D) in order to hide the fraudulent character of it.

Is carousel fraud limited to goods or does it also affect services?

Until recently, carousel fraud was only organised on intra-community supplies of goods (f.ex mobile phones or computer chips). Very recently, however, several Member States have been confronted with carousel fraud related to greenhouse gas emission allowances, which are considered as supplies of services within the EU.

Like for goods, this carousel fraud is made possible by the combination of a situation under which the supplier does not have to charge VAT to his client and a domestic transaction on which the normal VAT rules apply (domestic transfer of allowances). The very high mobility of these allowances (traded on specialised markets) and the very high amounts at stake are also an important element in this context.

Do we have figures on the overall amount of tax fraud in Europe?

Unfortunately, the Commission has no detailed figures on the level of tax fraud. Mainly because very few Member States make figures available. However, in the economic literature, estimates of tax fraud of 2 to 2.5% of GDP are mentioned. This would represent about 200 to 250 billion Euro at EU level.

On the VAT fraud, estimates of up to 10% of losses in VAT receipts are often quoted.

In order to have a clearer picture the Commission carried out a study on the amount of the VAT Gap in all Member States, the Results of this study will be made public in the coming weeks.

Why do we need a European action to combat tax fraud?

Tax fraud is a global phenomenon. Fraudsters are ahead of many companies and of tax administrations in terms of globalisation. In the context of the internal market, in particular, fraudsters take advantage of the four freedoms to move their activities very rapidly in order to escape from the reach of tax administrations that remain organised at a national level.

The free circulation of goods and services within the internal market but also the globalisation of the economy makes it practically impossible for a Member State to act individually against tax fraud. In order to address this phenomenon, there is a pressing need to define a coordinated action at EU level.

What are the EU rules on greenhouse gas emission allowances and what is the VAT regime applicable to them?

The EU emission trading system (ETS) was launched in 2005 and is now by far the largest multi-national scheme in the world (73 % in value of the global carbon market in 2008). The scheme is a "cap and trade" system whose objective is to cut greenhouse gas emissions by allocating emission allowances (allocated for free or auctioned) which can then be transferred between operators. Phase 3 of the ETS (2013-2020) will incorporate a yearly decrease of the cap of 1.74 % per year, arriving at a reduction of 21 % below the 2005 emissions.

From a VAT perspective, transfers of allowances between taxable persons are considered as a supply of service and are taxable at the place where the recipient is established.

How does this proposal relate to the former suggestion to introduce a generalised reverse-charge system?

The Commission presented in May 2006 a Communication in order to launch an overall debate at EU level on the need for a co-ordinated approach in the fight against fiscal fraud. Following the Commission's Communication of 23 November 2007, contributing to the establishment of an anti-fraud strategy within the EU and the report on the state of play within the Anti Tax Fraud Strategy (ATFS) expert group, the Commission presented a Communication on its analysis of more far-reaching measures to change the VAT system in order to fight fraud. One of the analysed measures was the establishment of a general reverse charge system and the Commission demonstrated its willingness, under certain conditions, to propose a pilot project so as to establish whether a type of generalised reverse charge system could be an appropriate response to VAT fraud. However, the ECOFIN Council could not agree on conclusions as regards the issues raised in this Communication.

The present proposal is however different from the above pilot-scheme idea on a generalised reverse charge mechanism.

Some Member States have requested, by means of a derogation granted by the Council, to combat fraud schemes via a targeted reverse charge system in relation to a particular fraud sensitive sector or to certain goods. However, because of the lack of detailed evaluation and impact assessment, these measures did not allow to fully assess the efficiency, effectiveness and proportionality of the measure, nor its internal market effects.

With this proposal, the Commission aims at providing the possibility for interested Member States to apply this targeted reverse charge mechanism in relation to a choice, from a pre-defined list, of goods and services which have been identified by Member States as sensitive to fraud. The experiences stemming from this temporary application of the sector-specific scheme should allow, on the basis of the foreseen information and evaluation procedure, an overall assessment of the usefulness and the proportionality of the sector-targeted application of reverse charge.

Source: European Commission