Richard North, 20/04/2019  

One of the moves of great genius perpetrated by the European Union is the adoption of Value Added Tax (VAT), a system so flawed that it has proved an absolute boon to criminals, costing the economies of EU Member States, over time, hundreds of billions of euros.

VAT fraud is so prevalent that it is estimated that over €150 billion is lost annually, with €50 billion attributable to cross-border fraud – an occupation so lucrative that it has spawned its own vocabulary.

The variant at the top of the current top-ten list is known as Missing Trader Intra-Community (MTIC) fraud. Last year, helpfully, Jari Liukku - a Europol official - told us that, "MTIC Fraud remains one of the most significant transnational frauds targeting all Member States".

Liukku went on to tell us that "staggering sums of money are being taken directly from the citizens of the European Union by organised crime groups", with the inevitable consequence that they are "depriving us all of essential services and infrastructure such as security, health, education or justice".

This is real money that is stolen: MTIC fraud is not a victimless crime. And, to deal with what is by definition an international cross-border offence, requires a coordinated approach between Member State police services, customs administrations and tax authorities. Nevertheless, says Liukku, "despite the various efforts made, the threat of MTIC fraud remains significant".

And of all the groups anticipating Brexit – and especially a no-deal Brexit - there are probably none more enthusiastic than VAT fraudsters, who stand to benefit by the breakdown of cross-border cooperation, to the tune of billions, to add to riches already acquired. Nor, by any means is this just a problem for the EU. The UK is likely to be particularly vulnerable, with the Irish border playing a star role.

Imagine if you will, a UK trading company in this brave new, post-Brexit world, at the start of an interesting adventure. It decides to import into the UK from the Far-East a container-load of consumer goods, with a landed value (known as the cost, insurance, and freight (CIF) price) of – for the purposes of this example - £200,000.

Let us assume (for convenience's sake) that there are no tariffs to pay. On entry to the country, though, there will still be a VAT liability, at 20 percent. At some time, therefore, the trading company will have to pay £40,000 – which it can then recover from its own customers.

This goes all the way down the line with the final customers copping the bill. And, if with profit margins and other add-ons, the final price of the consignment has risen to £400,000 (net of VAT), the tax man is going to get a neat £80,000.

In this case, though, the trading company has decided to re-export these goods to the Republic of Ireland. Assuming there are transit agreements in place, that means the sealed container can pass through the British port without the goods attracting any VAT liability. That liability will only be incurred by the Irish importer, once the goods have crossed the border into the Republic.

However, when it comes to this particular consignment, the truck carrying the goods makes an "unscheduled" stop in a discreet location, where the contents are removed. These may later be re-exported, having acquired a different identity, or sold on VAT-free on the UK market, through multiple outlets in the black and grey economies, so defrauding the revenue.

In this example, the container will be left empty and the truck will continue its journey, arriving in Northern Ireland via the Belfast ferry. It will then cross the land border into the Republic and, for the purposes of this adventure, "disappear".

Given that the UK decides to honour its GFA obligations and allow free passage across its border without checks, fraudsters will be able to rely on their trucks crossing into the Republic unmolested. They may be picked up by cameras as they travel south, and will be seen – as expected – crossing the border, out of UK jurisdiction.

Should such events have occurred before Brexit, the Irish tax authorities would have been notified of the transit of these goods, from the British port to the Republic. At some point, they will be expected to appear on the Irish system, attracting a VAT liability, data which will be forwarded to the UK authorities.

If, as in this case, goods haven't been physically transported to Ireland and remain in England, the missing consignment will raise red flags in the system. The authorities will start investigations which, in the fullness of time, might lead to fraud being detected.

Even then, the system is under extraordinary stress, and the UK has a patchy record for detecting fraud. In March 2017, a major fraud was highlighted by the EU's anti-fraud office, Olaf, where HMRC had displayed what was claimed to be "continuous negligence" in the handling of Chinese textile and shoe imports. The UK may end up having to pay €2.7 billion back to the EU, to compensate for loss of revenue.

And if this happened while we were in the EU, the system will be even more stretched in a post-Brexit world. Here, the UK will no longer be part of the EU's VAT system, and neither will it be a full participant in the EU's data-sharing networks. In the Irish situation, once consignments cross the border into the Republic, they will be "lost" to the UK authorities, and no further information as to their treatment can be expected as of right.

Yet, the scenario discussed in this article is only the most basic type of fraud, illustrating only the most general of dynamics. More usually, there are multiple layers of complexity. Then, opportunities multiply exponentially once you start factoring in the cross-border VAT rebate system. Perpetrators are highly sophisticated: they  work through networks of shell companies, across several borders, with the proceeds laundered in many different ways so as to avoid attention and evade the normal safeguards. 

After Brexit, for the UK even to begin to deal with this sort of crime, one of two things has to happen. The most effective and least obtrusive will be a comprehensive agreement with the EU – of which the Republic of Ireland will remain part – on VAT and data sharing. The aim will be to ensure that the cross-border VAT system runs much as it does today.

At this point, one has to observe that the EU has not entered into this type of agreement with any other third country – not even the Efta States. Nor will it as long as they lie outside the direct jurisdiction of the Commission and the ECJ. And that is why – in part – there are still checks on the border between Norway and Sweden, and on the Swiss border with EU Member States.

There lies the crucial issue. It is all very well talking about technological systems for monitoring traffic across the Irish (or any) border but, for these systems to work, there has to be perfect cooperation between the authorities on each side of the border, with harmonised systems and free sharing of data. And all this ceases to happen after Brexit, unless there are very serious, unprecedented cooperation agreements – which are unlikely ever to be agreed (at least in the short- to medium-term).

That, inevitably, will require us to adopt the second option: "Plan B". To detect and deter fraud, a high level of physical intervention will be essential. There is absolutely no getting around this - a requirement for a hard border, with trucks being stopped, paperwork checked and loads examined.

The theory that this can all be dealt with by remote monitoring and paperwork audits – the basis of "Max Fac" - is absurd. These sort of systems work on the assumption that traders are honest, and that there is a high level of cross-border cooperation.

But there will not be seamless cooperation and a proportion of traders are devious, and highly skilled criminals. With the riches at stake, they have become an extraordinarily sophisticated element within organised crime – an industry with the highest growth rate in the world. Without intensive border checks, the UK doesn't have a chance.

The same will also go for the EU Member States. Once the UK drops out of the EU's formal VAT system, it potentially becomes a back-door into the Union, with endless opportunities for sophisticated fraud. It would be naïve, therefore, to expect EU Member States to operate soft borders with the UK. Even if they tried, the European Commission would quickly step in and require the imposition of controls.

Largely, though, the entire VAT issue has become something of an "elephant in the room" in the Brexit debate. One only sees sporadic articles in the legacy media, and a smattering in the specialist press. The government has been suspiciously quiet, and largely uninformative, while the "ultra" MPs of the ERG remain firmly embedded in la-la land.

One has to remember, though, that the borders with the EU are multi-faceted. They are customs borders, they are borders between regulatory areas, and they are also tax borders. Even if we come to an agreement on tariffs with the EU, that does not in any way assure frictionless trade if we have a hard tax border, with the issue of VAT unresolved.

The single ray of hope in all this is that the EU has much to lose from the UK dropping out of the VAT system, so it may well be disposed to discussing cooperative arrangements. But, with the best will in the world, the very complexity means that negotiations will take time, and may well require uncomfortable concessions from the UK.

The degree to which the EU will accept continued UK participation in the system may also depend on the nature of the broader relationship. An Efta/EEA member will doubtless be afforded more concessions than if the UK was simply seeking a free trade agreement. But, to make things work, we need to go further than any Efta State has managed.

From an elephant in the room, VAT could be transformed into a straw that breaks a camel's back.

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