1. Countering Organized VAT Fraud in Enlarged Europe Lessons from Bulgaria June 23-24, 2006,Sofia, Boyana Conference Center Dr. Konstantin Pashev Center for the Study of Democracy Konstantin.pashev@online.bg Konstantin.pashev@online.bg Corruption and Organized Crime: Bridging Criminal and Economic Policies

2. “Sizing” the problem  EUR 60 billion a year according to EC estimates Germany: EUR 18 billion; UK from GBP 1-2 billion in 2004-2005 fiscal year to 5 billion in the last fiscal year and a forecast of 7 billion in the current one.  Bulgaria Revenue authorities’ estimates: EUR 150 million annual average of detected fraud, but this is between a half and one fourth of total fraud, i.e. according to most conservative estimates of 50 % detection rate tax fraud amounts to over EUR 300 million, i.e. over 20 percent of VAT revenues. World Bank estimates for 2002 point at EUR 450 million (33% of VAT revenues). I.e. the leakage as a percent of VAT revenues is 4- 5 times bigger than in Europe.

3. Conventional tax evasion vs. organized fraud  Individual evasion: hiding of tax liabilities  Undervaluing of sales receipts through recording of lower prices or quantities  Overvaluing of spending on inputs  The size of the fraud is limited to the size of the value added at each stage of the supply chain

4. Conventional tax evasion vs. organized fraud  Network VAT fraud: net cash inflow to the crime network from the abuse of the right to VAT credit  The objective is not to reduce tax liability but to siphon VAT credit.  Conventional evasion goes with real transactions, while here paper transactions and fictitious traders prevail  There are accomplices up the supply chain as well as in the tax and customs administrations and other law enforcement agencies  The size of the fraud is unlimited

5. Conventional tax evasion vs. organized fraud  The borderline between abuse of credit for VAT evasion and VAT drawing may seem elusive and a matter of scale rather than content  Individual evasion implies complicity by suppliers, or clients, and it is often done through recording of non- existing transactions.  But drawing of credit in Bulgaria usually implies VAT audit, i.e. it cannot be done without pre-fixed fraudulent network with the collusion of senior level tax and customs officers.  It has important practical implications:  The Bulgarian penalty code for instance contains provisions against tax evasion, but not against VAT fraud as a crime network.

6. The mechanics of organized fraud  Fictitious exports  The smallest network on the border of individual and network VAT crime: comprises only the beneficiary and accomplices from the tax and customs offices  Missing/Insolvent trader fraud

7. Carousel Fraud

8. The Bulgarian Experience  Conventional barriers to the abuse of tax credit  Deduction from future tax liabilities instead of net cash refund  Refund is only after tax audit  Principle of joint liability  The VAT account  Additional safeguard against the missing/insolvent trader fraud  Relief from the principle of joint liability for compliant taxpayers

9. X-type VAT fraud (with VAT account) If O sells on the domestic market the scam effect is EUR2200 (the tax collected from the cash buyers). With a fake export the effect doubles 11000 VA: 10000 13200 11000 VAT +2200 VAT -2200 VA: 1000

10. The challenge of the single market  Physical border control on the cross-border flow of goods is no more applied to intra-community trade  Voluntary VAT registration below the threshold  Pressure towards differentiated rates

11. May the credit mechanism be replaced  The self-enforcement advantages: built-in safeguards against conventional evasion  Taxing final sales only?  The alternative subtraction method of charging VAT  The problem for exporters. The value of tax on inputs remains in the export price  The problem for suppliers of tax exempt goods, or goods charged at lower rates  The problem for investors  Reverse charge system

12.  Barriers to the use of prices deviating from the market ones? Only as input in the risk- assessment rather than grounds for legal action.  Barriers to the registration of fake undertakings through strengthening controls at entry? A better tool would be to make transfer of ownership possible only after VAT audit  Reducing the opportunity for evading responsibility by the organizer - Optimizing the principle of joint liability Reducing the normative opportunities for the abuse of credit

13.  Standard of service for processing of refund application  Personal responsibility for the auditor who has refused the refund without grounds as proven in court procedure  Improving the effectiveness of audit  Modern risk management system based on information system with incentives for companies with e-invoicing  Optimizing the audit system: principles of selection of firms and auditors and administrative accountability  Corruption risk assessment through monitoring of individual audit performance Reducing the normative opportunities for administrative discretion and corruption

14.  The administrative sanctions need to be tied to the size of the fraud.  Criminal liability for participation in fraudulent VAT network Sanctions

15. A sound standardized methodology of assessing the size of the fraud is most important Thank you Monitoring and evaluation of the impact of the anti-fraud instruments