VAT fraud, where one business charges another business VAT and fails to pay it over to Revenue, is big business.  It is relatively straightforward to perpetrate and has a cost to EU member states running to billions. 

It can be difficult to detect: Typically an extensive and complicated chain of transactions in several countries is used to cover up what is happening.  Very often the fraud takes place in relation to the sale of high value small items, such as computer chips or phones, but it can apply to a broad range of goods.  

VAT fraud, like all tax fraud, deprives the exchequer of valuable resources.  That loss is felt most acutely in times such as these when the State is struggling to fund much needed public services.  So where a business is knowingly involved in VAT fraud it should of course be liable to the full rigours of the law. 

But how should a business that is unknowingly involved in VAT fraud be treated?  A business can conduct a large number of transactions every day in good faith, only for it to emerge that one of these was in fact fraudulently conducted without the knowledge of the business. How should the innocent party be dealt with?

According to EU VAT law if a business “should have known” that it was involved in VAT fraud then it can be held liable for the defrauded VAT and possibly penalties.   As VAT on goods in Ireland is generally at a rate of 23%,  the potential cost for a business can be very significant.  Therefore, a business must take steps to ensure that it is not an unwilling participant in transactions that could ultimately be connected with a VAT fraud. 

Revenue have just issued detailed guidelines setting out what a business can do to avoid being penalised in this way where there is VAT fraud.  Revenue’s view is that, on an ongoing basis, a business should assess the integrity of its supply chain, customers, suppliers and goods.  It provides detailed examples of the actions that a business could take to avoid being party to a series of transactions connected with fraud and having to pay a large VAT liability.  

Some of these are very onerous and seem to place an unfair burden on legitimate law-abiding businesses.  Some of the steps suggested by Revenue are quite impractical and do not adequately take account of the daily realities and lack of resources faced by many businesses. 

For example, it is suggested that when setting up a trading relationship a business could first obtain a signed letter of introduction to its business associates on headed paper; that it could establish the trade history of a supplier; that it could obtain written trade references and follow through on them to ensure that they are genuine.

There is more.  A business could obtain credit checks or other background checks from an independent third party.  It could “make a visit to the new partner’s premises whenever possible”.  The Revenue guidelines document adds: “This is not an exhaustive list and Revenue recommends that these are supplemented where necessary in each of the above categories to ensure that you are not caught up in fraudulent transactions.” 

These proposals would bring the level of policing by a business of its suppliers to a new level.  They would add to the administrative burden on businesses, would be quite time consuming and would add delays to the business of actually doing business.

Furthermore, the responsibility for policing VAT fraud rests with the Revenue who has the power to audit any business to ensure its compliance with VAT rules.  This responsibility must not be effectively transferred to businesses. In this regard the EU court has held that businesses are not obliged to carry out checks on the other party to a transaction. 

Yes, some businesses can knowingly collude with or turn a blind eye to the VAT fraud of others. However a more appropriate test for a business could be whether, mindful of the existence of fraud, it had acted reasonably and in a manner consistent with generally accepted commercial practice in its business sector. This should not require them to conduct a thorough process of investigation of their suppliers before doing business with them. 

Revenue should also consider updating the guidelines to focus on the specific type of goods that are likely to be the subject of fraud, rather than suggesting checks on all transactions. For business transactions likely to be at risk of fraud,  a business should have a simple process to identify any risky transactions which can then be considered in more detail as required.  This should be enough.

This process could be integrated into existing processes and should take account of the particular feature of the individual business. For some businesses it may be that any transaction, or series of transactions, with a new supplier or customer over a certain monetary value is reviewed. 

Businesses, and indeed all citizens, have a responsibility to take reasonable steps to avoid complicity in tax fraud, and to report it when they suspect it. But these latest guidelines would oblige businesses to develop a level of policing activity which frankly isn’t really their business.

John Stewart is a Tax Director at Deloitte specialising in VAT.