Carousel fraud 'out of control'

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Carousel fraud, which has cost the UK billions in lost value added tax (VAT), is out of control, a House of Lords committee has warned.

It says the measures used by HM Revenue and Customs (HMRC) to stop fraudulent VAT claims are unsustainable.

The peers warn that a forthcoming change to the UK VAT system will simply shift the fraud from goods like mobile phones to others instead.

But HMRC says its measures have sharply curtailed the level of attempted fraud.

"Our strategy is not unsustainable," a spokesman said. "It is working."

In the 2006-07 financial year the value of trade associated with attempts at this fraud fell dramatically.

The trade dropped from £17bn in the first six months to just £800m in the second six months, with the prospect of a similarly sharp fall in the level of actual fraud suffered by the exchequer.

Extra investigations

The fraud typically involves criminals repeatedly trading goods, such as mobile phones and computer chips, across the borders between EU states - trade which under EU rules is exempt from VAT.

In over 95% of cases..... HMRC have found that the traders have either been participating in or profiting from trading linked to MTIC fraud HMRC

Once the goods are imported, they are then sold on within the country - but the importer then dodges the VAT it should be paying.

Yet when the criminals finally export the goods once more, they reclaim the VAT which in theory should have been paid at the start of the chain, triggering a loss to the taxpayer.

The report from the House of Lords European Union committee says the HMRC's main current strategy, of carrying out many extra checks to stop fraudulent reclaims, is not only unsustainable but also inefficient.

The committee queries whether the HMRC can really sustain this level of checking, given that it involves about 1,500 staff, at a cost of £95m a year, with some supply chains under scrutiny involving up to 600 companies.

The Lords say this also carries the danger of withholding money from legitimate, smaller, importers and traders, possibly pushing some to the brink of bankruptcy.

But the HMRC said its present approach was stopping a huge amount of fraud.

"To date, in over 95% of cases where VAT returns are subject to extended checking, HMRC have found that the traders have either been participating in or profiting from trading linked to MTIC fraud or further investigation is necessary," said its spokesman.

"Only 1% of the VAT withheld under the extended checking programme has been found to be correctly claimed and properly repayable."

Reverse charge

From 1 June this year the VAT system in the UK will change, so that the high value, low-weight, goods mainly used by carousel fraudsters - mobile phones and computer chips - will be taxed in a different fashion.

The committee expect that, even with the reverse charge, carousel fraud will continue to migrate and mutate Lords committee report

Under a system known as the "reverse charge", VAT will only be levied and collected when the items are sold at the end of the supply chain, for instance to customers in a shop or to a trader who is not VAT registered.

This will end the opportunity for criminals to arrange the repeated import and export of the same goods, dishonestly reclaiming VAT each time.

The committee claims the new policy will simply push the criminals, thought to be a few hundred sophisticated gangs, to move their attention to other goods - such as cosmetics, precious metals, and computer software.

"The committee expect that, even with the reverse charge, carousel fraud will continue to migrate and mutate," said the report.

New system needed

During this decade carousel fraud has been one of the worst attacks ever seen on the UK tax system.

Losses reached an apparent peak in 2005-06 when, according to Treasury estimates, between £2bn and £3bn was lost to the fraudsters.

The Lords concluded that the fraud, which is a huge problem across Europe, will only be ended if there is a complete overhaul of the European system of VAT.

They call for a flat rate of VAT, at 15%, to be levied on all cross-border trading in the EU, instead of - as is currently the case - exports to other EU countries being free of the tax.

However, it is well established that the UK and other EU governments are against such a step.