The Latvian approach for tackling VAT fraud Irina Andrejeva State Revenue Service of Latvia Trilateral Conference on “ Tax and social fraud” April 20, 2012 The Hague

International transaction chain under general VAT scheme (standard case) Company A (supplier) Company B (intermediary) Company C (exporter) LVL 90 + VAT LVL 0 LVL 100 + VAT LVL 22 LVL 110 + VAT LVL 24,20 LVL 120 + VAT LVL 0 VAT return Calculated VAT LVL 22 + 19,80 - Input VAT LVL 19,80 = VAT due to pay LVL 22 Calculated VAT LVL 24,20 - Input VAT LVL 22 = VAT due to pay LVL 2,20 VAT return Calculated VAT LVL 0,00 - Input VAT LVL 24,20 = VAT refundable VAT return VAT due LVL 22 VAT due LVL 2,20 VAT refund LVL 24,20 STATE BUDGET VAT revenue 0 LVL

International transaction chain under general VAT scheme (fraud case) Company A (supplier) Company B (intermediary) Company C (exporter) LVL 90 + VAT LVL 0 LVL 100 + VAT LVL 22 LVL 110 + VAT LVL 24,20 LVL 120 + VAT LVL 0 Missing Trader VAT return Calculated VAT LVL 22 - Input VAT LVL 0 = VAT due to pay LVL 22 Calculated VAT LVL 24,20 - Input VAT LVL 22 = VAT due to pay LVL 2,20 VAT return Calculated VAT LVL 0,00 - Input VAT LVL 24,20 = VAT refundable VAT return VAT due LVL 22 VAT due LVL 2,20 VAT refund LVL 24,20 STATE BUDGET VAT revenue 0 LVL

VAT difference from other taxes VAT significantly differs from other taxes: Taxpayer is granted possibility to benefit by getting VAT refunds from the state budget (real money) even in case when there were not any VAT payment made ever to the state budget, i.e. steal the money from the budget

Protection of the VAT system The goal Not allow non-compliant and potentially risky companies to join the VAT system as well as timely identify those members of VAT system that are already possibly involved in artificial transaction chains aiming to avoid paying VAT to the budget or steal VAT from the budget – cause the losses to the budget Available mechanisms Pre-registration controls Post-registration controls De-registration from VAT registry Tools Early warning system for changes in registration data of legal persons Problems The behavior of the company may change after acquiring VAT number in result of changes in company’s registration data – additional controls are needed Relatively simple and easy procedure of company registration in Registry of Enterprises

VAT registration early warning system The goal of Early warning system is to help timely identifying taxpayers, whose possible aim is tax evasion Analysis is performed every day on registration data of all legal persons Analysis results are used: to make decision on registration or refusing of registration in VAT register; to start activities for de-registration procedure.

VAT registration early warning system Risk criteria Information on addresses and phone numbers Legal address is acknowledged as risky Official’s declared place of residence is acknowledged as risky address Company’s or official’s phone number is acknowledged as risky Information on officials Actual or former official is acknowledged as risky person Change of company’s loner official Official has no declared place of residence Information on characteristics Company is involved in transaction chain Criminal procedure is initiated (for company and official) Official is connected to fictitious company

Detection and Prevention Information Legal aspects IT tools International cooperation

Information sources 1. Taxpayers' registration information Registration information about legal persons is electronically received from Registry of Enterprises: name, tax identification number, address, officials, shares. Registration information about natural persons is electronically received from Registry of Population: name, surname, relatives, address etc. Information on branches, taxes, phone numbers etc. reported to tax administration by taxpayer 2. Information from tax returns, reports and statements VAT return with annexes (input tax, turnover, IC acquisition, recapitulative statement) Annual report Corporate income tax return Personal income tax return Statements on social contributions and personal income Others (returns on natural resources, excise returns etc.) 3. Information on tax payments

Information sources 4. Information on actions taken by tax administration tax controls VAT refund claims risk analysis enforcement communication with taxpayer, visits etc. 5. Information from tax administration departments customs information – all data from customs returns – SAD (Customs Department) criminal cases (Financial Police Department), actions taken in the excise field (Excise Department) 6. Explanations registry explanations on companies economic activities given by the officials of risky companies 7. Registry of Fictitious companies companies assumed by tax administration as risky ones and meeting certain criteria (e.g. registered, using the documents of the third persons; company‘s owner or official is person without place of residence; information on company is included in Explanations Registry; can not be found at the company’s legal address as well as at owner’s or official’s place of residence etc.)

Information sources – VAT return Report on the input tax and tax amounts included in the VAT return is annex of VAT return – an integral part of the VAT return and consists of three parts: Input tax for the goods acquired and services received inland Input tax for the goods and services received from the MS of the EU Tax for the goods supplied and services supplied Following information is provided in each part of the report: counterparties (name, VAT number) transaction date transaction value type of transaction !!! This information gives huge possibilities to detect risky transactions at early stage

Information sources – Third party information Registration information on companies, nongovernmental organizations, political parties etc. (registration number, name, officials, owners, address, phone number etc.) Information about insolvency procedure Registration information on natural persons (identification number, name, surname, passport, status, marriage, relatives etc.) Information on real estate (name, owner, address, documents related to real estate etc.) Information on issued permits for timber cutting, cut timber amounts Information on contracts between state and private companies on forest logging Information on bank accounts' numbers of legal persons Information on issued permits for construction Information on licenses issued (construction, transportation, operations with metal scrap etc.) Information on companies with detected illegal employees

Information sources – Third party information Information on registered vehicles, tractors, aircrafts, ships Information on administrative penalties imposed Information on invalid documents Information on issued work permits and residence permits Information on border with third countries crossing facts by third country citizens Information on transactions with carbon credits made by persons registered in Latvian Emission Trading System Information from VAT Exchange information System (VIES) on IC-supplies made to Latvian taxpayers and on IC-supplies between other EU member states’ taxpayers Information from EUROFISC network Information on amounts of acquisitions of goods and services made by the Bulgarian and Romanian taxpayers from Latvian counterparties Information on international information exchange (SCAC requests, MLC, requests on direct taxes)

Legal aspects Detailed information on all domestic and cross-border (IC and import both for goods and services) acquisitions for which input tax is deducted as well as out-coming transactions – obligation of each taxpayer an integral part of VAT return submission is obligation of each taxpayer Detailed information on transactions with counterparties where the value of each transaction is below LVL 1000 (~ EUR 1422) but the total value exceeds LVL 1000 (in force since 01.03.2012.) Special transaction type code to identify transactions made using CPC 4200 Reverse charge transactions with timber (since 01.07.1999.) transactions with scrap metal (since 01.10.2011.) construction services (since 01.01.2012.)

Technical aspects – IT tools Other information sources Tax information system (TIS) Central Customs information system Information system for state officials declarations Information exchange system VIES DATA WAREHOUSE State Land Service Ministries State Forest Service Others Queries

Technical aspects – control possibilities Taxpayer A Taxpayer B To identify mismatches in the data declared in VAT returns of the both supplier and customer cross-checks of the VAT returns data is performed: Domestic transactions Correspondence of the data on acquisitions reported in VAT return by the customer (taxpayer A) including acquisitions made under the reverse charge mechanism with data on made supplies declared in VAT return by supplier (taxpayer B) – possible illegitimate deduction of VAT input tax in case of mismatch Correspondence of the data on made supplies reported in VAT return by the supplier (taxpayer A) including transactions made under reverse charge mechanism with data on acquisitions declared in VAT return by customer (taxpayer B) – possible underreporting of turnover in case of mismatch

Technical aspects – control possibilities VIES data Taxpayer C Customs data Taxpayer A To identify mismatches in the data declared in VAT returns of the both supplier and customer cross-checks of the VAT returns data is performed: Cross-border transactions Correspondence of the data on IC-acquisitions reported in VAT return by the customer (taxpayer A) with data on made IC-supplies declared by supplier in other EU MS – possible involvement in carousel fraud scheme, illegitimate application of VAT 0% rate, failing to fill in the VAT return in case of mismatch Correspondence of the data on import or export of goods declared in VAT return of the taxpayer with customs data from SAD (single administrative document)

Technical aspects – control possibilities Illegitimate deduction of input tax Transactions with counterparties assumed as risky by tax administration. Taxpayer assumed to be risky one in following cases: de-registered from VAT register de-registered from VAT register after the transactions made have "fictitious" feature the criminal process is initiated “negative discrepancy” is detected the explanation is submitted that officials have no connection to the enterprise and its economic activity “buffer” company

Indicators of the “buffer” company Technical aspects – control possibilities Indicators of the “buffer” company huge turnover per one employee VAT payable to budget fluctuates by LVL 0 (even if turnover is huge) no bank accounts are registered in Latvian banks and the turnover is huge transactions with risky taxpayers small number of employees (1-3), low salaries small number of business partners who are supplying goods or services to taxpayer (2-5 companies) changes of company’s officials company’s official is connected to risky company taxpayer can not be found at reported addresses

Intra-community transactions Technical aspects – control possibilities Intra-community transactions Verification of VAT numbers of counterparties VAT registration numbers of the counterparties reported in the VAT return input tax annexes and recapitulative statements are sent to EU using VIES immediately after including the data in tax administration data base OMCTL error messages are received back from EU through VIES Customs procedure 4200 Data reported in recapitulative statements are cross-checked with customs data on import of goods under customs procedure 4200 – determination of taxpayers right to apply the derogation In input tax annex of the VAT return information on intra-community acquisitions of goods imported to EU under customs procedure 4200 are available – ensuring traceability Customs data Taxpayer A

Intra-community transactions Technical aspects – control possibilities Intra-community transactions Illegitimate application of VAT 0% rate counterparties have invalid VAT numbers; large amounts of supplies but number of employees is inappropriate. Taxpayer is a member of artificially made transaction “chain” Large amount of acquisitions, but small number of employees small number of transactions no VAT payments to the budget all amount of goods is supplied with 0% there is no supply within the country Supplied goods to EU are purchased from “fictitious” counterparties ; Taxpayer is included in EUROFISC information as suspicious counterparty; Taxpayer’s counterparties are included in EUROFISC information as suspicious taxpayer.

Technical aspects – IT tools

International cooperation EUROFISC SCAC 2004 and SCAC 383 requests Multilateral controls International conferences, forums, experience exchange, seminars and workshops Expert networks (i.al. informal communication of the experts)

Problems Non-compliant taxpayers are always one step ahead of the tax administration Tax administration work is fighting with consequences nevertheless it is necessary to prevent the possibility of tax fraud at the very early stage Legislation is fragmentary adjusted to tackle certain type of VAT fraud Exemptions and derogations from regular rules gives opportunity to non- compliant taxpayers to use bottlenecks and loopholes of the system Mechanisms of international cooperation and mutual assistance have heavy and time-consuming procedures – time is money Information exchange between EU member states need to be improved. Weak cooperation with third countries – improvement is needed VAT system in EU is harmonized still the work of the tax administrations is not harmonized – different approaches are used, differences in competences, different level of knowledge, experience and expertise, difference in capacity and resources available

SPEED AND RAPID REACTION ARE NECESSARY Problems Non-compliant taxpayers are always one step ahead of the tax administration Tax administration work is fighting with consequences nevertheless it is necessary to prevent the possibility of tax fraud at the very early stage Legislation is fragmentary adjusted to tackle certain type of VAT fraud Exemptions and derogations from regular rules gives opportunity to non- compliant taxpayers to use bottlenecks and loopholes of the system Mechanisms of international cooperation and mutual assistance have heavy and time-consuming procedures – time is money Information exchange between EU member states need to be improved. Weak cooperation with third countries – improvement is needed VAT system in EU is harmonized still the work of the tax administrations is not harmonized – different approaches are used, differences in competences, different level of knowledge, experience and expertise, difference in capacity and resources available SPEED AND RAPID REACTION ARE NECESSARY

Time for the reforms “Value Added Tax (VAT) is paid for by citizens, collected by businesses and accounts for over 20% of national revenues. It therefore has a significant impact on every single EU citizen. However, it is now 40 years since the EU VAT system was first set up, and the regime no longer fits with our service-driven, technology-based economy. The time has come for an ambitious VAT reform.” Aļgirdas Šemeta, Commissioner for Taxation, Customs, Anti-fraud and Audit Brussels, 6 December 2011

Time for the reforms “Missing trader intra-community fraud (MTIC) is a “EU-only” fraud. MTIC relies on EU VAT rules specific to intra-community sales of goods and supplies of services.” Richard T. Ainsworth, Boston University School of Law Boston University School of Law Working paper No. 10-39 “VAT Fraud: MTIC & MTEC – The Tradable Services Problem” (November 12, 2010)

Time for the reforms Till now introduced and proposed improvements of the VAT system were “cosmetic”, not solving problems on the merits Existing VAT system with growing number of derogations and exemptions creates loopholes that with pleasure are used by non-compliant taxpayers VAT system by itself causes problems the consequences of which it will eventually have to fight against

Which of these solutions is the right and effective one?.. Possible solutions The possible solutions are: continue making “cosmetic” improvements in the existing VAT system but bigger attention should be paid to taxpayers right to deduct input tax (i.e. obligation for the taxpayer to inform tax administration before certain type of transaction is performed and to invite tax administration as observer as condition for getting deduction rights) prediction of the new trends and making appropriate amendments in the legislation changing to cash accounting principle – deduction is allowed after real payment is made not after receiving the invoice turnover tax – tax due is calculated as defined percentage form the turnover, no deductions allowed Which of these solutions is the right and effective one?..

Thank you for your attention! Ms. Irina Andrejeva   Chief tax inspector State Revenue Service of Latvia, Tax Control Board Tax control planning and analysis division Risk analysis methodology unit  +371 67028861  Smilsu iela 1, Riga, LV-1978, Latvia @ Irina.Andrejeva@vid.gov.lv