A U.K. Crown Court has convicted four men of operating a £30 million value added tax (VAT) fraud, the Kent News reports. Her Majesty's Revenue and Customs investigators say the individuals had claimed more than £18 million (US $30.1 million) in VAT repayments through their company, Amber Communications Ltd. The company imported mobile phones and computer chips from Europe and the United States, then sold them along a contrived supply chain before ultimately exporting the same goods. Investigators say the company did not pay VAT it had charged on the original goods. The individuals will be sentenced this month.
A VAT is a form of consumption tax, similar to a sales tax, that is used in many countries around the world. The value added to a product by a business is the sale price charged to its customer, minus the cost of materials and other taxable inputs. A VAT is like a sales tax in that ultimately only the end consumer is taxed, but a sales tax is collected and remitted to the government only once, at the point of purchase by the end consumer. With a VAT, collections, remittances to the government, and credits for taxes already paid occur each time a business in the supply chain purchases products.
This is the basis upon which the fraud gang in this case operated to defraud the U.K. government. Although case details are not provided in the news report, it appears that these fraudsters not only failed to pay the VAT owed on cell phones and computer parts they imported, but also faked the collection of VAT from a fictitious U.K. supply chain and then claimed them for a refund. This is known as a "carousel deal," in which a good is actually, or at least on paper, shifted several times among several firms to qualify for fraudulent input tax refunds. On the positive side of the case, authorities caught the fraudsters before they disappeared, which often happens in such circumstances.
From an audit perspective, a significant part of what can be learned relates to the effectiveness and efficiency of fraud risk assessments and targeting of planned audits. Governments and their tax collection organizations, with resource limitations, frequently must use materiality thresholds and other risk criteria to focus their efforts. That can mean that certain industries, such as the automotive industry, receive more audit attention than others because of the relatively higher amounts of VAT/sales taxes involved. Balanced fraud risk assessment and audit work will ensure, over time, that most if not all industries receive audit attention, and that the major risk factors beyond materiality are assessed.
There also is the question of controls and their effectiveness. Tax rules tend to be fairly complex, yet they may not necessarily be well-coordinated among tax categories. As one example, in the case of the U.K. VAT system, the refund of the input tax is independent of whether and when the bill is paid and also independent of whether the seller has paid the VAT shown in the bill to tax authorities. It further does not matter whether or not the buyer has received sales revenue that is subject to VAT and must therefore pay VAT itself. These "silos" can lead to undesired losses of tax revenue, which may point to a need to review and potentially modify particular tax rules.
If the tax rules themselves cannot be addressed, the basic processes and documentation involved in sales transactions ought to be reviewed and tightened where warranted. Auditors no doubt will focus on appropriate documentation, which in this case includes an audit trail that is backed up with valid VAT receipts. Details are always important: For example, credit card vouchers aren't sufficient to claim back VAT unless they contain all the details normally found on a VAT receipt, including the supplier's VAT information. Furthermore, one could consider ways to further strengthen process documentation and controls, for example, by using a single tax number for a seller and a buyer, along with one number representing the invoice, and a requirement that the seller use an intermediate bank trust account — or similar arrangement for credit card sales — that reconciles and pays the VAT owed to tax authorities and also the net amount of the bill to the seller.