How carousel fraud is putting the VAT system in a spin

The spiralling costs of a sophisticated cross-border scam are punching a £10bn-a-year hole in the Treasury’s finances.

It's a sophisticated kind of cross-border VAT fraud, which involves both tax evasion and the straightforward theft of money from HM Revenue and Customs (HMRC). In its simplest form, a fraudster obtains a VAT registration to acquire goods tax-free from a trader in another country within the European Union. Typically, these goods are small, high-value, easily transportable items, such as computer chips or mobile phones. The goods are then sold on at a higher, VAT-inclusive price, but the seller disappears without paying the tax to HMRC. Officially, this type of crime is known as "missing trader intra-community" (MTIC) fraud.

Because, unfortunately, the fraud doesn't end there. Instead, the goods are sold on through a series of VAT-registered UK companies some

of which might be innocent buffers' aimed at putting distance between the import and the export and then re-exported to another EU member state. Incredibly, the goods are often sold back to the original exporter, and all the transactions take place on the same day, with the goods themselves sitting in the same warehouse until re-exported. Moreover, the same goods will typically be circulated time and time again, hence the term carousel' fraud. This kind of fraud differs from straight tax evasion because there's a double-whammy loss to the authorities. Not only does the original importer of the goods abscond with the VAT money, but the re-exporter fraudulently reclaims' the (never-paid) VAT from HMRC. In a development that suggests that the scale of the fraud can only get bigger, some criminals have now even developed virtual carousels', using false document trails and money transfers to create the impression that trading has taken place.

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It's already huge, and getting bigger very quickly as organised criminals move in on the large-scale gains available. According to official figures, carousel fraudsters accounted for £7.4bn worth of EU imports in the first quarter of 2006, out of a total of £45.7bn. Latest estimates from HMRC put the second quarter figure at £10bn, suggesting a plausible full-year figure of £35bn if the scale of fraud steadies at the current rate. That's triple the figure for 2005 and ten times the figure for 2004.

Putting an exact figure on this is hard and the authorities dislike it when journalists try to do so. They say they will not have an accurate picture of 2006's losses until the end of 2007. However, the last published figures are those for 2004/2005, when HMRC say they lost somewhere between £1.1bn and £1.9bn on fraudulent trade of £3bn.

So if the fraud has increased tenfold to more than £30bn as official figures suggest it's realistic to suppose a loss to the UK tax coffers in excess of £10bn a year. Earlier this year, a senior HMRC source admitted to The Guardian that they were already losing the equivalent of "two Tonbridge robberies a week". That's £100m, or £5bn a year, since when the scale of the fraud has continued to grow.

More than enough. To build and equip a dozen hospitals or three hundred secondary schools costs £5bn a year. And £10bn a year is the equivalent of 3p on the basic rate of income tax. The effect of the surge in carousel fraud has already made a huge dent in the Treasury's VAT receipts. In last year's Budget, Gordon Brown pencilled in a rise in VAT receipts of £3.5bn for 2005/2006. Instead, receipts actually fell by £170m the first ever annual decrease since the tax was introduced in 1973.

The tax authorities have doubled the number of staff deployed on carousel fraud from 500 to 1,000 in the past year. The issue hit the headlines earlier this month when 400 customs officers and 100 police mounted 60 dawn raids in Glasgow, Manchester and London. Fifteen arrests were made. There have been five recent trials in which 16 carousel fraudsters were jailed, with another dozen or so cases due to come to court this year.

No, it's a problem across the EU. Because the VAT system is EU-wide, individual countries cannot make unilateral changes. Any reforms of the system need unanimous approval. In order to end the fraud completely, the EU would need a root-and-branch reform of its VAT system, which eliminates the need to reclaim VAT when goods are shipped across internal borders. This is currently being investigated by the EU's tax commissioner, Laszlo Kovacs, but any change is likely to be years away.

Carousel fraud started in the rag trade in the 1970s, says Ashley Seager in The Guardian. It gained a new lease of life about six years ago in the Midlands, as criminals started pulling VAT scams involving mobile phones. These days, serious and organised criminals are moving in. Investigators at HMRC say there is evidence of Russian mafia involvement in EU carousel fraud, while Dublin tax authorities say the IRA has also been involved. In all, Revenue & Customs believe 9,000 people in the UK are involved in the swindle, from warehouse and clerical workers to well-heeled accountants and ruthless gangland hardmen.

Simon Wilson’s first career was in book publishing, as an economics editor at Routledge, and as a publisher of non-fiction at Random House, specialising in popular business and management books. While there, he published, a bestselling classic of the early days of e-commerce, and The Money or Your Life: Reuniting Work and Joy, an inspirational book that helped inspire its publisher towards a post-corporate, portfolio life.   

Since 2001, he has been a writer for MoneyWeek, a financial copywriter, and a long-time contributing editor at The Week. Simon also works as an actor and corporate trainer; current and past clients include investment banks, the Bank of England, the UK government, several Magic Circle law firms and all of the Big Four accountancy firms. He has a degree in languages (German and Spanish) and social and political sciences from the University of Cambridge.