White Collar Crime: Taken for a ride

Carousel trading costs the EU more than £40bn a year. And governments are still struggling to clamp down on the practice. By Monty Raphael and Neil Swift

If you have read a newspaper in the past five years, you could have failed to notice stories about carousel frauds. The UK Government, in common with other EU governments, has been subjected to a sustained and virulent criminal attack arising from an abuse of the common VAT system, itself a feature of the single market created in 1993. Described then as a transitional measure, destined to be replaced and, presumably, made secure in 1996, the continued failure of the member states to agree on a permanent scheme has provided easy access to fraud on a quite phenomenal scale.

As with all criminal statistics, based partly on empirical evidence and partly on anecdote, the figures are only indicative. Nevertheless, the UK alone has lost an average of around £2bn a year with a spike in 2005 running at around £100m a week. In the EU as a whole, the loss has been put at around E60bn (£40.77bn) annually.

A widespread problem
The basic criminal idea is quite straightforward: invest in acquiring goods (usually, but not always, mobile phones or computer chips) or devise a system of virtual acquisition and supply and sell into a carousel or circular group that may or may not be made up of traders in the know. The goods/virtual goods are then exported to another member state and the duty reclaimed, often to be recycled in the financing of a new carousel.

This activity is not apparently confined to the EU. A recent Financial Action Task Force (FATF) report recites similar cross-border schemes operating in other countries, such as Mexico and the Ukraine. Nor are mobile phones or computer chips the only commodities. They are, however, the goods of choice because they are of high value and low physical volume.

HM Revenue & Customs (HMRC) has adopted a variety of approaches to confront carousel fraud. Initially the response was conventional. Law enforcement would investigate, prosecute, and if possible convict, the malefactors. But the number of frauds grew and it became clear that state resources were simply inadequate. Even now, with reportedly 1,500 or so personnel addressing the problem (a greater number than those confronting drug trafficking or alcohol and tobacco smuggling), the conventional methods are unequal to the task. How else does one explain the increase in revenue losses year on year, which are only now beginning to subside.

Sometime at the end of 2001 and the beginning of 2002 the Government embarked on a new strategy. Unable to even identify, let alone prosecute, all the perpetrators, HMRC worked on the assumption that the majority, if not all, of those buying and selling telephones and computer chips were up to no good, unless of course they could prove the contrary. The new policy was to disrupt the trade by either delaying or denying repayments of VAT. Months passed while HMRC investigated all the individual trades in a sequence, circular or linear.

Where, however, there was circularity of supply, and notwithstanding the absence of any evidence of fraud, HMRC asserted that the trading was an example of “non-economic activity” and was thus outside the scope of the Sixth VAT Directive. Therefore, HMRC maintained, however innocent the trader, VAT could not be reclaimed and the trader must suffer the loss, often running into many millions of pounds.

The first cases to be decided by the VAT and Duties Tribunals were Bond House Systems (2003) and the combined appeals by Optigen (2003) and Fulcrum Electronics (2003). In each case the tribunal found in favour of HMRC and many millions of pounds continued to be withheld from a large number of registered traders. Bond House, Optigen and Fulcrum were among a large number of traders against which no allegations of dishonesty was made. These three cases were eventually referred to the European Court of Justice (ECJ), which found in their favour, but not until January 2006.

Treasury measures
Meanwhile, the Treasury, becoming increasingly concerned about losses from carousel frauds, introduced provisions in the Finance Act 2003 imposing joint and several liability on traders in the offending sector. One effect of this legislation was to persuade traders that the risk of non-recovery of VAT was too high and to lead them to cease trading altogether. It is by no means certain that only delinquent traders were deterred in this way because losses continued to rise.

The companies venturing to conduct legitimate business formed a pressure group and attempted – unsuccessfully as it turned out – to have the 2003 legislation declared as being in breach of EU law.

Delaying payments and moving the statutory goalposts were not the only weapons in the Treasury’s armoury. It argued that, if trading in telecoms and computer chips might involve fraud, then, or so the argument went, banks affording facilities to traders in these commodities will surely suspect them of money laundering. Such was the pressure on UK banks to form a less than charitable view of all traders in the sector that they followed one another quite rapidly in denying bank accounts to any trader in computer chips and mobile phones. They took this quite draconian step again regardless of any proven misconduct.

The recent experience of traders in the vulnerable sector has been to suffer exceptionally long delays in processing claims for repayment or in some cases equally long delays in applications to register for VAT. In Kittel v The Belgium State (2004), the ECJ decided that, where it was ascertained having regard to objective factors that the supply was to a taxable person who knew, or should have known, that by their purchase they were participating in a transaction connected with fraudulent evasion of VAT, it was for the national court to refuse that taxable person entitlement to the right to deduct.

HMRC cited Kittel to justify the thoroughness of its processes so that it could investigate whether the trader knew, or had the means of knowing, that there was a missing trader somewhere in the chain.

All the various measures taken by governments of EU states to confront this criminal activity have so far proved only partially successful. One would have imagined that, with losses running at the rate of billions of euros a year, the finance ministers of these states would have found some common ground, but so far the nearest they have come to an agreement is to permit the UK to introduce the so-called reverse charge – limited, of course, to mobile telephones and computer chips. It is not yet clear whether this is sufficient to overcome the ingenuity of the Europe-wide criminal community.

Certainly, neither the UK Government nor the other members of the single market have shown themselves equal to the law enforcement task of preventing a massive raid on their revenues. In trying to confront the problem the UK Government has had to resort to wholesale demonisation of a trading sector and extra-statutory, and unlawful, disruption methods.
Monty Raphael is head of the fraud and regulatory group and Neil Swift is an assistant at Peters & Peters