Session 9 Case Studies on Frauds in Value Added Tax

1. Session 9Case Studies on Frauds in Value Added Tax Regional Training Institute Jammu Audit of VAT

2. Session Overview • In this session we will discuss some case studies on ‘Frauds in Value added Tax’. Audit of VAT

3. Learning Objective • At the end of this session the learner will be able to comprehend the possibilities of frauds committed by dealers in pocketing value added tax collected from consumers. Audit of VAT

4. International experience of frauds in Value Added Tax • The main types of fraud on VAT are: Audit of VAT

5. Classification fraud • this type of fraud occurs in a multi-rate VAT situation where dealers take advantage of multiple rates by classifying goods carrying higher rates as goods carrying lower rates. Audit of VAT

6. Missing trader frauds • Such frauds occur in UK where fraudsters register for VAT, buy goods VAT free from another EU Member State, sell them on at VAT inclusive prices and then disappear without paying the VAT due to Customs. Audit of VAT

7. Missing trader frauds • In Indian context, such frauds can take place when a trader imports goods (either from outside India or from another State), sells them to another dealer after charging VAT and then disappear without paying VAT into public exchequer account. The purchasing dealer can claim ‘input tax credit’ of the tax paid by him, without the Tax Administration receiving the revenue. Audit of VAT

8. Shadow economy fraud • genuine businesses with a turnover above the VAT registration threshold that deliberately do not register for VAT. Audit of VAT

9. Repayment frauds • where fraudsters register for VAT, make false claims for repayments and then abscond. This fraud is similar to a missing trader fraud. Audit of VAT

10. Suppression fraud • where genuine businesses with legitimate trading activity perpetrate a fraud by understating a portion of their sales or by falsely inflating their claims for the VAT on purchases to reduce their tax liability. Audit of VAT

11. Impact of fraud • VAT frauds also (in addition to Tax Administration) impact genuine VAT registered businesses, which may, unknowingly be drawn into the vortex of ingenious schemes designed by organized fraudsters. Audit of VAT

12. Impact of fraud • It is, therefore, important for dealers also to be aware of the possible areas where fraud can occur so that they can be vigilant and do not unwittingly become party to an organized fraud as in the case of a "missing trader fraud" or "cloning fraud". Audit of VAT

13. Impact of fraud • There are instances in the UK where genuine businesses have been charged with being a party to a fraud with huge demands being slapped on them to the point that if they fail to succeed in appeal, the businesses faced imminent closure under the impact of the demand raised by the department. Audit of VAT

14. Self-policing mechanism, a myth • A much-professed benefit claimed for VAT was that it was `self-enforcing' in a way that other indirect taxes were not. As VAT is paid at each stage of production, in order to claim credit for the VAT paid on its inputs against the VAT received on its outputs, a business would need to show, if required, that the VAT had been paid by its suppliers. Audit of VAT

15. Self-policing mechanism, a myth • `One man's proof of purchases is evidence of another man's sales.' There would be no incentive for two traders to fail to invoice a transaction between them, as the purchaser's liability for VAT would be increased by the amount the supplier had not been recorded as paying. Audit of VAT

16. Self-policing mechanism, a myth • Tax could still be evaded by failing to invoice final customers or tax-exempt purchasers and there was further potential for evasion in wrongly classifying untaxed and taxed goods. Audit of VAT

17. VAT avoidance techniques • The different types of VAT avoidance techniques encountered internationally may be categorized as follows: Audit of VAT

18. Disintegration • This involves artificial fragmentation of business into smaller units to keep the turnover below the threshold limit and avoid registration under VAT. In India, this may probably happen only in the case of retail traders. Audit of VAT

19. Partial exemption • Partial input-tax credit is required to be calculated when tax-paid inputs are either used in the manufacture partly of tax-paid goods and partly exempt goods or when the goods purchased are sold partly to taxable entities and partly to exempt entities. By exploiting the rules which apply to partly exempt supplies, traders recover substantially more tax than was intended. Audit of VAT

20. Partial exemption • This can be plugged by providing for practical rules of apportionment of input tax credit between taxable and exempt sales. Audit of VAT

21. Types of VAT fraud • The different types of VAT frauds encountered internationally may be categorized thus: Audit of VAT

22. Suppression of output • This is a deliberate act of a VAT-registered dealer not to record all his sales. This is more prevalent in those trades where cash payment is common. Audit of VAT

23. Undervaluation of output • This is the most infamous form of evasion. Here, the unit declares a price that is lower than the actual. This may again be done in two ways. • Usually, the taxpayer gets into an understanding with the receiver of goods and a lower price is declared in the documents. The taxpayer may decide to totally ignore his counterpart if he is daring enough to forge documents and replace the genuine ones. Audit of VAT

24. Mis-declaration of quantity • This is resorted to whenever there is little scope of undervaluation and where counting or measurement of quantity is a prohibitively problematic task. Audit of VAT

25. Mis-declaration of quantity • The advantage is that: i) there is little scope of detection from documentary audit or scrutiny, and so, ii) once the consignment is cleared out there is virtually no way to establish that an evasion had been effected. Mis-declaration of quantity is a common form of evasion. Miscalculation may also take place. Straightforward errors of calculation, either in computing the assessable value or the tax liability, may be restored to by the taxpayer. Audit of VAT

26. Some of these frauds are Audit of VAT

27. Incorrect classification of goods • Detected in Punjab; • Home based inverters were taxed at 12.5% VAT while UPS was taxed at 4%; • Three companies sold ‘Inverters’ as home-based UPS; • Charged VAT at 4%; • Caused loss to State exchequer; Audit of VAT

28. Incorrect classification of goods • This type of fraud can be committed by dealers and manufacturers in other States also, may be not on ‘Inverter/UPS’ pair of goods attracting different VAT rates, but on other similarly placed goods. • Auditors have to be careful while checking the classification of goods and applicable VAT rate while checking a sample of tax returns. Audit of VAT

29. Value Added Tax-free Exports from the Channel Islands • Channel islands are sovereign countries but dependencies of UK; • Small Value goods costing less than GBP 18 are exempt from payment of VAT under EU guidelines; • Small value items like CD players and DVD players costing less than GBP 18 are sold from Channel islands to consumers in UK through internet based sales; Audit of VAT

30. Value Added Tax-free Exports from the Channel Islands • These goods are in fact manufactured in UK, exported to Channel Island, tax free, and then sold to consumers in UK through internet based or telephone orders; • Such a sale is again tax free under the EU Guidelines causing loss of business to UK retailers and loss to UK exchequer; Audit of VAT

31. Value Added Tax-free Exports from the Channel Islands • UK Government is taking action to stop this illegal practice; • In the Indian context, such a fraud is a possibility with the mushrooming of internet based sales and tele-shopping based sales, both of which are based on the concept of placing the order either through internet or over phone and receiving the goods through postal system or couriers. Audit of VAT

32. Value Added Tax-free Exports from the Channel Islands • While the audit of records of a Tax Administration may not reveal such types of frauds, auditor can ascertain if the Tax Administration is keeping a tab on such sales and purchases in their area of jurisdiction and collecting data on such sales and purchases. Audit of VAT

33. Missing trader fraud • Missing trader fraud (also called Missing Trader Intra-Community, MTIC, or carousel fraud) is the theft of Value Added Tax (VAT) from a government by exploiting the way VAT is treated within multi-jurisdictional trading. Audit of VAT

34. Missing trader fraud • The fraud exploits the fact that the movement of goods between EU member states is VAT-free. The fraudster charges VAT on the sale of goods, and then instead of paying this over to the government's collection authority, simply absconds, taking the VAT with him. Audit of VAT

35. Missing trader fraud • In the Indian context, such a fraud can take place in the inter-State sales also. Inter-State sales are VAT free. The goods may be imported into tax jurisdiction of a State tax-free by an importer, sold to a wholesale dealer, after charging price plus VAT. The wholesale dealer would sell the goods to the retailer after charging VAT. Audit of VAT

36. Missing trader fraud • The wholesaler would pay to the Tax Administration net VAT (VAT charged less VAT paid). The retailer after selling the goods to the final consumer may either pay VAT to the TAX Administration in the same manner as the wholesale dealer (output tax less input tax) or may pay a lower turnover tax. If in the above example the importer vanishes without paying VAT to Tax Administration, the Tax Administration would be put to a loss. This can be the missing trader fraud in the Indian context. Audit of VAT

37. Missing trader fraud • Such a fraud can be detected by the Tax Administration or by Audit through cross interlinking and cross referencing of input tax and output tax of different dealers and different invoices. Once detected by Tax Administration, or on being pointed out by Audit, action has to be taken to trace out the missing dealer (importer in the above example), collect the Vat and penalty and, if necessary initiate criminal proceeding against him for the fraud. Audit of VAT

38. Tackling VAT Fraud- Report by CAG of UK • Discussion on the report of the Auditor General of UK. Audit of VAT