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The New VAT Civil Fraud Procedures

Category Technical Articles
AuthorTechnical Department
Article by David Patrickson, Head of Indirect Taxes at The Taxserver Limited. The article appeared in the September 2002 issue of Tax Adviser.


  • How does VAT legislation fit into today’s business society?
  • A brief review of a typical civil fraud investigation - the practitioner’s viewpoint
  • New procedures and how they differ from what we are used to
  • Crystal ball gazing to try and put the latest developments into focus
On 28 March 2002 Customs & Excise announced that from the start of the following month they would be adopting a new approach to tackling value added tax (VAT) evasion. The new procedures would lead to a more low-key approach, which, it was claimed, would ultimately lead to the benefit of the taxpayer. Having tried the new procedures in the East Midlands, London and the North-west they were now ready to be rolled out nationally to give fresh impetus to the fight against VAT evasion. The legislation, found in the Value Added Tax Act 1994 (VATA 1994), s. 60, VAT evasion: conduct involving dishonesty, has not changed. What have changed are the procedures used by Customs which underpin the course of the investigation itself.

Looking at the legislation, VATA 1994, s. 60 applies to cases where, for the purpose of evading VAT, a person does any act or omits to take any action and his conduct involves dishonesty. So there has to be a degree of intent and there has, on the part of Customs, to be evidence of this intent. If found guilty, a penalty of 100 per cent of the sum evaded can be sought.

In the context of a late 20th to early 21st century world, the penalty is targeted at the shadow economy. It is not aimed at organised crime nor is it the weapon of choice to be used against perpetrators of international carousel fraud. And its use, successful or otherwise has to be considered in that context.

So just how big is the shadow economy in the United Kingdom (UK)? Nobody knows for certain. Estimates vary depending on where you look, and the range is as wide as you like. Anywhere from two per cent to 15 per cent of gross domestic product (GDP). Probably not as great as in the United States of America , or European countries such as Italy. But, if in the upper quartiles of the estimates, as is likely, still a worryingly large amount to be missing from an already overstretched exchequer. If perhaps ten per cent of taxable transactions are not recorded it is inevitable that the impact on VAT revenues will be colossal. The total number of VAT fraud investigations completed in any one year only rarely reaches as high as 1,000. This barely scratches the surface. The problem - time and resources.

There cannot be many practitioners of the black art of VAT who have not at some time been involved in a VAT investigation. They seem to follow a similar pattern. There is the initial contact from a taxpayer, occasionally one from within your own client base. He has been visited, perhaps unexpectedly, by Customs officers. They have accused him of paying less than is his due by way of VAT. This initial contact, if you decide to become involved, is usually followed by a series of meetings with your new client at which all suggestion of impropriety of any sort are strongly denied.

Then comes a meeting with the case officers where the evidence set out and quantified. At this point the seriousness of the matter is stressed and penalties are explained. The scale of the penalty, at 100 per cent of the VAT evaded, concentrates the mind and mitigation of up to 75 per cent is that carrot that generally teases the truth - sometimes even the whole truth - out of its box.

As far as a time scale is concerned you are generally talking about months rather than weeks. Often the truth is slow to emerge. Sometimes it does not even make an appearance. In many cases the scale of any irregularities reduce dramatically as factors not previously taken into account come to light, such as wastage, theft or the fact that certain supplies are eligible for zero-rating. In most cases the case officers will be involved in other cases. They will have to juggle their time and you will have to fit in with that.

If at the end of it all you have done your job well, your client stays in business a more chastened individual. He has not paid more by way of arrears than was fair and the level of penalty applied is realistic. This is the ideal objective. Sometimes you reach it and sometimes you don’t. Sometimes you have to settle for the best you can achieve. But it all takes time.

So how, if at all, will the new procedure change things? The starting point remains the same. There is no procedure at all if there is no evidence that irregularities have occurred. So Customs officers will continue to carry out their information gathering processes. There will still be tip-offs from disgruntled former employees. Observations will continue to be made. Test purchases will continue to be bought. In other words, evidence will continue to be gathered. And this will continue to be done covertly.

It is how this evidence is used that is so different from in the past. First of all Customs will write to the taxpayer advising him that they suspect irregularities in his VAT affairs. He will be invited to a meeting to discuss the matter with case officers. The letter gives no indication as to what the suspected irregularities might be. Accompanying this letter will be the Customs & Excise Statement of Practice for the new system, which tells the taxpayer what to expect. You can download it from the Customs website.

At the meeting, at which an adviser should in all conscience be present, one of the case officers will ask the following four questions, which are designed to generate yes/no type answers:

  • Have any transactions been omitted from, or incorrectly recorded, in the books and records of (name of legal entity) with which you are (responsible status)?
  • Are the books and records you are required to keep by Customs for (name of legal entity) with which you are (responsible status), correct and complete to the best of your knowledge and belief?
  • Are the VAT returns of the (name of legal entity) which you are (responsible status) correct and complete to the best of your knowledge and belief?
  • Were you aware that any of the VAT returns were incorrect or incomplete at the time that they were submitted?

You will know all about the questions in advance and so should be able to handle this aspect. Meetings will not normally be taped and should be held in a relatively informal and much less hostile atmosphere. However, some degree of stress is almost inevitable.

If the taxpayer wishes to maintain his innocence there is nothing in the new procedures that can stop him. Customs will simply follow the traditional route to closure. Remember, at this moment the taxpayer is still unaware of what evidence Customs hold against him and the closed nature of the questions have encouraged a degree of frankness.

If irregularities are admitted, they are generally discussed, but at the meeting it is not advisable to dwell on these. At this point Customs may ask for a payment of arrears on account, but it is by no means crucial to the outcome. Under the new regime the taxpayer will be asked to produce a report detailing the scale and nature of the evasion, and quantifying it, as far as is possible, on a VAT accounting period basis. This is a critical aspect of the process as the taxpayer is still operating in ignorance of the evidence against him. Only when he has quantified the irregularities can he gauge from the case officer reaction to what extent his disclosure has been believed. It is at this stage that the relationship between the taxpayer and the adviser is so important. As a worse case scenario, where a materially false disclosure is produced, the investigation could take on a much more serious air, with criminal proceedings a possibility at the end.

Hopefully the report will be accepted and the arrears will be agreed. The case cannot proceed to its conclusion until this happens and negotiations at this stage are likely. If the taxpayer has fully co-operated, the penalty can be mitigated down to 20 per cent of net arrears. Time to pay arrangements can be arranged. Customs are showing signs of more pragmatism in this area than they have done in the past.

Is the new procedure better than the old one? From what I have seen of it I think that it probably is, as long as both sides act reasonably. It is flexible enough to allow for negotiation where appropriate. The fact that the taxpayer effectively gives evidence against himself speeds the process up. A penalty of 20 per cent with mitigation for full co-operation is eminently fair; some would say generous bearing in mind that fraud has been committed and admitted. There is even the added ‘bonus’ of a joint disclosure to the Inland Revenue, which might be quite cost efficient as far as professional fees are concerned.

But there is always a but. Any measure to prevent revenue leaking from the exchequer is to be applauded and the new approach to VATA 1994, s. 60 investigations falls within this category. However, to date, and as far as I know, in the future, cases are dealt with by staff from the Customs & Excise National Investigation Service. These are a scarce resource with a wide remit that ranges from dangerous drugs and pornography through white vans full of cheap beer and tobacco to VAT fraud of all shapes and sizes. They are the individuals we use to plug up the sea defences against a rising tide of problems and they are running out of sandbags.

We may see the number of cases completed rise when compared with previous years. But even if the number of completed cases doubles or trebles the impact on the shadow economy will still be minimal.

For those businesses unfortunate enough to find themselves involved in an investigation I have seen real benefits. However, in order for the new procedure to work effectively on the broader stage we will need to see a significant increase in the number of staff trained to carry it out.

Technical Department
020 7235 9381

September 2002 by David Patricksony


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