Transcript Session 9 Case Studies on Frauds in Value Added Tax

Session 9
Case Studies on Frauds in Value
Added Tax
Regional Training
Institute Jammu
1
RTI Jammu
Audit of VAT
Session Overview

2
In this session we will discuss some case
studies on ‘Frauds in Value added Tax’.
RTI Jammu
Audit of VAT
Learning Objective

3
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.
RTI Jammu
Audit of VAT
International experience of frauds in
Value Added Tax

4
The main types of fraud on VAT are:
RTI Jammu
Audit of VAT
Classification fraud

5
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.
RTI Jammu
Audit of VAT
Missing trader frauds

6
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.
RTI Jammu
Audit of VAT
Missing trader frauds

7
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.
RTI Jammu
Audit of VAT
Shadow economy fraud

8
genuine businesses with a turnover above
the VAT registration threshold that
deliberately do not register for VAT.
RTI Jammu
Audit of VAT
Repayment frauds

9
where fraudsters register for VAT, make false
claims for repayments and then abscond.
This fraud is similar to a missing trader fraud.
RTI Jammu
Audit of VAT
Suppression fraud

10
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.
RTI Jammu
Audit of VAT
Impact of fraud

11
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.
RTI Jammu
Audit of VAT
Impact of fraud

12
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".
RTI Jammu
Audit of VAT
Impact of fraud

13
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.
RTI Jammu
Audit of VAT
Self-policing mechanism, a myth

14
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.
RTI Jammu
Audit of VAT
Self-policing mechanism, a myth

15
`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.
RTI Jammu
Audit of VAT
Self-policing mechanism, a myth

16
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.
RTI Jammu
Audit of VAT
VAT avoidance techniques

17
The different types of VAT avoidance
techniques encountered internationally may
be categorized as follows:
RTI Jammu
Audit of VAT
Disintegration

18
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.
RTI Jammu
Audit of VAT
Partial exemption

19
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.
RTI Jammu
Audit of VAT
Partial exemption

20
This can be plugged by providing for
practical rules of apportionment of input tax
credit between taxable and exempt sales.
RTI Jammu
Audit of VAT
Types of VAT fraud

21
The different types of VAT frauds
encountered internationally may be
categorized thus:
RTI Jammu
Audit of VAT
Suppression of output

22
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.
RTI Jammu
Audit of VAT
Undervaluation of output


23
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.
RTI Jammu
Audit of VAT
Mis-declaration of quantity

24
This is resorted to whenever there is little
scope of undervaluation and where counting
or measurement of quantity is a prohibitively
problematic task.
RTI Jammu
Audit of VAT
Mis-declaration of quantity

25
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.
RTI Jammu
Audit of VAT
Some of these frauds are
26
RTI Jammu
Audit of VAT
Incorrect classification of goods





27
Detected in Punjab;
Home based inverters were taxed at 12.5%
VAT while UPS was taxed at 4%;
Three companies sold ‘Inverters’ as homebased UPS;
Charged VAT at 4%;
Caused loss to State exchequer;
RTI Jammu
Audit of VAT
Incorrect classification of goods


28
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.
RTI Jammu
Audit of VAT
Value Added Tax-free Exports from the
Channel Islands



29
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;
RTI Jammu
Audit of VAT
Value Added Tax-free Exports from the
Channel Islands


30
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;
RTI Jammu
Audit of VAT
Value Added Tax-free Exports from the
Channel Islands


31
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.
RTI Jammu
Audit of VAT
Value Added Tax-free Exports from the
Channel Islands

32
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.
RTI Jammu
Audit of VAT
Missing trader fraud

33
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.
RTI Jammu
Audit of VAT
Missing trader fraud

34
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.
RTI Jammu
Audit of VAT
Missing trader fraud

35
In the Indian context, such a fraud can take
place in the inter-State sales also. InterState sales are VAT free. The goods may be
imported into tax jurisdiction of a State taxfree 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.
RTI Jammu
Audit of VAT
Missing trader fraud

36
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.
RTI Jammu
Audit of VAT
Missing trader fraud

37
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.
RTI Jammu
Audit of VAT
Tackling VAT Fraud- Report by CAG of
UK

38
Discussion on the report of the Auditor
General of UK.
RTI Jammu
Audit of VAT