Missing trader fraud, also known as Missing Trader Intra-Community (MTIC) fraud, is the abuse of the VAT rules on cross-border transactions within the EU. It relies on the fact that no VAT is chargeable on these transactions.
In a typical VAT supply chain where there is no fraud a VAT-registered business which buys and sells goods charges VAT to customers (called output tax) and is charged VAT by suppliers (called input tax). The business can reclaim the VAT it has paid and so it passes to HMRC the net VAT it collects (output tax less input tax) or reclaims from HMRC any excess input tax.
MTIC fraud was originally prevalent in sectors such as IT and mobile phones. However, the criminals have moved onto other asset classes such as precious metals, power, gas and carbon emissions allowances and telecoms.
HMRC frequently tries to recover lost tax by denying input tax recovery from 'innocent' businesses in the supply chain. MTIC fraud is therefore a concern for legitimate businesses who need to carry out due diligence on their supply chain and customers.
How does MTIC fraud work?
There are a number of different kinds of VAT fraud. This is how they work.
Acquisition fraud
A 'missing trader' purchases goods from a supplier located in another EU state. Because this is a cross-border transaction within the EU the supplier does not have to charge VAT
The missing trader then fails to pass to HMRC the VAT it charges on supplies to UK customers.
Carousel fraud
The missing trader purchases goods from a supplier located in another EU State. The missing trader then sells the goods to a business and charges VAT. The missing trader then disappears without paying the VAT to HMRC.
The buying business sells the goods to a second business and charges VAT. It pays the excess VAT received from the second business to HMRC.
The same happens on a sale between the second business and any third and subsequent business.
The last business in the chain sells the goods to a broker. The broker exports the goods to an EU customer without charging VAT as this is a cross-border transaction within the EU. The broker then reclaims the VAT he has paid when purchasing the goods. In doing so, the broker is effectively reclaiming the VAT not paid by the missing trader and crystallising HMRC's loss.
Contra trading
In acquisition fraud and carousel fraud HMRC first becomes aware of the fraud when the broker submits his claim to HMRC. Contra-trading eliminates this step making detection even more difficult for HMRC.
In contra-trading the 'broker number one' does not submit a claim to HMRC to obtain a refund of the VAT charged to it. Instead, he uses a 'clean' deal chain to offset the VAT. This means that he imports goods from another EU state, and no VAT is payable on that transaction.
The broker number one is therefore effectively able to eliminate the economic effect of the VAT charged to it by purchasing goods of an equivalent value from the EU. HMRC will only become aware of the fraud when broker number two or another innocent party down the supply chain submits a claim for a refund of input tax.
What are the weapons used by HMRC to combat MTIC fraud?
Reverse charge mechanism
The VAT due on a supply is normally accounted for to HMRC by the supplier. Since 1 June 2007 the reverse charge mechanism has applied to supplies of mobile phones or computer chips if the supply is valued at £5,000 or more and is made by one VAT-registered business to another, so that the customer, rather than the supplier, must account for VAT on the supply.
This is a special derogation which was initially due to remain in force until 31 December 2013 but has now been extended to 31 December 2018. In 2010, the reverse charge mechanism was extended to services in order to combat MTIC fraud in the carbon market. This means that the reverse charge applies to transactions in emissions allowances.
On 1 August 2012 the European Commission adopted a proposal for a Quick Reaction Mechanism (QRM) that would enable member states to respond more swiftly and efficiently to VAT fraud. This means that member states can apply, within the space of a month, a reverse charge mechanism. This has led to HMRC using the reverse charge mechanism on a wider range of products and at very short notice.
In July 2014 the reverse charge was introduced on wholesale supplies of gas and electricity between counterparties established in the UK to make the customer liable to account for the VAT. It does not apply to domestic supplies or to businesses that are not registered or liable to be registered for VAT.
From 1 February 2016, the VAT reverse charge applies to wholesale supplies of routing telephone calls and associated data over landlines, mobile networks or the internet. It does not apply to supplies to non-business customers or those who are not VAT registered.
Joint and several liability for unpaid VAT
This only applies to supplies of equipment for use as a telephone or a computer as well as some other electronic equipment such as digital cameras, camcorders, iPods, Playstations and some other goods.
Any business in a supply chain of goods which have been the object of MTIC fraud can be held liable to pay the VAT which is unaccounted for if the relevant person "knew" or "had reasonable grounds to suspect" that the VAT on the supply or on any previous or subsequent supply had been unpaid.
A business will be presumed to have "reasonable grounds to suspect" if it has purchased goods for less than their lowest open market value or the price payable by a previous supplier in the chain.
HMRC has published guidance (Notice 726) on the types of checks a business should carry out in order to avoid being unwittingly liable. HMRC recommends checking:
• the legitimacy of customers or suppliers (e.g. their trade history)
• the commercial viability of the transaction (e.g. the existence of a market for the goods)
• the viability of the goods (e.g. the existence and condition of the goods).
If HMRC considers that the appropriate checks were carried out, they will not apply the joint and several liability rules.
Loss of the right to claim input tax
The Court of Justice of the European union held in 2006 (in the Kittel case) that a trader can lose his right to reclaim input tax where "it is ascertained, having regard to objective factors, that the taxable person knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT".
Following the ECJ's decision the Court of Appeal held in 2010 (in the Mobilx case) that the relevant test was whether the trader "should have known that its transactions were connected with fraud. That (...) could be established by demonstrating that it ought to have known that the only reasonable explanation for the circumstances in which the transactions in question were undertaken was that they were connected with fraud."
The loss of the right to reclaim input tax is of a much wider application than joint and several liability. It can apply to any type of goods and can occur in circumstances where the trader did carry out appropriate checks.