MASTER THESIS
“The Difference Between Tax Avoidance and Tax Evasion”
Written by
Daniel Davidov
ANR: 264901
2016
SUPERVISOR: Nebojsa Jovanovic
Second supervisor: Gert-Jan van Norden
Master Thesis International Business Taxation
Track:International Business Tax Law, Tilburg School of Law, Tilburg University
Daniel Davidov
ANR: 264901
SUPERVISOR: Nebojsa Jovanovic
Second supervisor: Gert-Jan van Norden
2016
Table of Contents
Abstract……………………………………………………………………………………………..1
1.
2.
3.
Introduction…………………………………………………………….........................................1
2.1.
Introduction of the topic…………………………………………………………...……. 2
2.2.
Motivation ………………………………………………………………………………..2
2.3.
Conclusion……………………………………………………………………………….. 2
Legal methods of tax avoidance…………………………………………………………………… 3
3.1 tax avoidance……………………………………………………………………………….......3
3.2 VAT and methods of legal computation………………………………………………………..3
3.2.1 Subtraction method vs. invoice-based credit method……………………………………4
3.3 Destination Principle vs. Origin Principle. ……………………………………………………5
3.4 Exemptions provided by VAT Directive…………………………………………………….. 6
3.4.1 Exemptions for triangular transactions………………………………………………… 6
3.4.2 Exemption related to international transport……………………………………………7
3.5 VAT grouping allows tax avoidance………………………………………………………….8
3.5.1 VAT grouping and Commission view…………………………………………………. 8
3.5.2. CJEU versus European Commission view……………………………………………..8
3.5.3. Full application of FCE rules to overseas supplies by Netherlands and UK…………..9
3.5.4. VAT advantages could lead to tax avoidance or tax evasion…………………………..9
3.5.5. Conclusion……………………………………………………………………………. 10
3.6. The idea behind tax avoidance……………………………………………………………… 10
3.7. The difference between tax avoidance and tax evasion……………………………………. 10
3.8. Real movements of goods versus fictitious transport………………………………………. 11
3.9. VAT as a tax law……………………………………………………………………………. 13
3.10. Zero rated exports are of massive significance for any kind of fraudulent
behavior……………………………………………………………………………………………………. 14
3.10.1 Export subsidy provided by VAT…………………………………………………….. 14
3.10.2. Conclusion…………………………………………………………………………….15
3.11. Avoiding VAT registration………………………………………………………………….15
3.12. Tax avoidance via reverse charge mechanism………………………………………………16
3.13. Changing the residence………………………………………………………………………17
4. Tax evasion…………………………………………………………………………………………….18
4.1. Tax evasion – definition and measuring……………………………………………………….18
4.2. Two concepts for the link between tax avoidance and tax evasion……………………………19
4.2.1 The key difference between tax avoidance and tax evasion……………………………….19
4.2.2 Arguments supporting the concept of none-differentiation between both terms…………..19
4.2.3 Consequences of overstepping the tiny link between tax avoidance and tax evasion……..20
4.2.4. Conclusion…………………………………………………………………………………20
4.3. Offshore registration……………………………………………………………………………….21
4.4. Schemes of tax evasion and frauds……………………………………………………………… 21
4.4.1 Accounting for less than committed……………………………………………………….21
4.4.2 Unjustifiably claiming a tax credit or refund of tax paid………………………………21
4.5. Tax frauds………………………………………………………………………………………22
4.5.1. Definition………………………………………………………………………………….22
4.5.2. Mechanism of VAT fraud……………………………………………………………
22
4.6. Typical tax frauds in Balkan Peninsula……………………………………………………………24
4.6.1. Carousel fraud…………………………………………………………………………… 24
4.6.2. Example of carousel fraud………………………………………………………………24
4.6.3. Missing trader fraud…………………………………………………………………… .26
4.6.4. “Missing traders fraud”………………………………………………………………… 27
4.6.4.1. Tax consequences in Bulgaria……………………………………………………27
4.6.4.2. Tax consequences in Romania…………………………………………………..28
4.6.4.3. The idea behind the scheme………………………………………………………29
4.6.4.4. Conclusion……………………………………………………………………….29
4.6.5. X-type VAT fraud…………………………………………………………………
29
4.6.5.1 Financial return on the x-type VAT fraud…………………………………………30
4.6.5.2 Unlawful refund scenario…………………………………………………… ……30
4.6.6. The most typical VAT fraud in Balkan Peninsula……………………………………………31
4.6.6.1. Financial and tax advantages from the scheme……………………………………..33
4.6.7 Selling of invoices to real business entities……………………………………………34
4.7. Tax evasion or tax fraud................................................................................................ ...............35
4.7.1 Restaurant management through artificial companies……………………………… 35
4.7.2The postponed payment facilitates tax evasion……………………………………… 36
4.8. Conclusion……………………………………………………………………………………
38
5. Conclusion………………………………………………………………………………………………39
6. References……………………………………………………………………………………………… 41
1. Abstract
Today, technological progress and world globalization have created a modern vision of free
trade principles, which allow cross-border trade around the world. The movement of goods across
international borders is the basis of the greatest creation of wealth in the history of the world.
However, every trade, domestic or cross-border is deeply related to paying taxes, which is presumably
the worst thing for businesses. Usually to avoid paying taxes or just to reduce their amount, businesses
include invoices issued by fake companies, or issued by legal companies but without real deals and
movement of goods, in order to accumulate expenditures for higher tax relief. The difference between
tax avoidance and tax evasion is definitely miniscule. One could argue that both terms are
approximately the same, however even this tiny difference makes them worlds apart. Tax avoidance is
the legal method of reducing the tax amount and tax evasion is the illegal, related to committing tax
frauds. Although often used interchangeably, there are very substantial differences between tax
evasion and tax fraud. Tax evasion refers to the use of illegal means to avoid paying taxes. This could
include felonies, such as refusing to pay a required tax amount once it has been assessed.
Nevertheless, tax evasion includes misdemeanors such as failing to file a return. Tax fraud on the other
hand refers to lying on tax returns and falsifying tax documents and is always a felony charge. In this
Master’s thesis the difference between tax avoidance and tax evasion will be clarified with an
introduction of typical tax frauds committed in the Balkan Peninsula as a research question.
2. Introduction
2.1.Introduction of the topic
Paying taxes is a responsibility and obligation levied by the government in the face of the tax
authorities. Usually, business companies consider that the respective tax amount required by the tax
authority based on their profit is too high. Consequently, the tax amount should be decreased by legal
and illegal means and methods. The lawful way to reduce the tax amount is via tax avoidance.
However, very often businesses bend the tax rules and legislation while trying to achieve the desirable
amount of tax obligation. Obviously, the difference between tax avoidance and tax evasion is very
small as most of the methods of reducing the tax amount are illegal according to tax law and
legislation. Multinational companies use various ways to pay lower amounts of taxes. They establish
branches in countries with a low rate of corporate tax, for instance in Bulgaria – only 10%, 1deal with
themselves from VAT point of view, importing goods from third countries, using various loopholes in
domestic or international legislation and exporting goods to companies registered in member states.
This is done in order to use the rights provided by the VAT Directive in the face of a destination
principle. If properly applied, zero rating removes exports from all VAT burden – exporters do not
1
http://www.tradingeconomics.com/bulgaria/corporate-tax-rate
1
collect VAT when exporting, however they are still eligible to claim for refunds of all the VAT paid in
their input purchase.However, sometimes the business crosses the line of permitted limits levied by
domestic and international legislators and conduct activities that could be described as a criminal way
of tax evasion in the face of tax frauds. In this occasion, typical tax frauds committed in Balkan
Peninsula will be discussed in this master thesis as a research question.
2.2. Motivation
My previous experience as a police investigator in the Economic Department of Varna,
Bulgaria motivated me to use my experience and knowledge as the research topic, describing the
small but might difference between tax avoidance and tax evasion. My previous experience was
focused on tax and financial frauds, committed in the Balkan Peninsula with the participation of
Bulgarian companies – legitimate and fictitious. Usually, the typical scheme is between companies
from Greece, Romania and Bulgaria. Notwithstanding, sometimes the “chain” starts from Turkey, as
Turkey is not part of the EU area, which sometimes provides an additional advantage. The research
question has a deep relation with the main topic, however it focuses on the business “world” with its
both sides – legal and illegal as well as taxation in a very specific part of Europe – the Balkan
Peninsula. This is the most strategic place in Europe from a trade and criminal standpoint, due to its
geographical position. Apparently, Bulgaria is a transit area and connection with Asia, which allows
committing a wide range of crime with Bulgarian participation directly or indirectly. Nevertheless,
Bulgaria has the lowest rate of annual corporate tax, only 10%, which leads to many international
investments and foreign establishments which lead to various tax schemes and frauds.
Notwithstanding, all tax frauds use the benefits provided by the VAT Directive – zero rate of export
transaction and exemption method, so that the research question will be made on the basis of the VAT
Directive and various domestic tax legislations. As a method of research and materials for the thesis,
various cases from the Regional Court of Justice – Varna will be used, web sources, literature and
academic materials. Nevertheless, examples of specific tax frauds will be disclosed. In this occasion I
will share my experience and especially how a particular business can commit a tax fraud without
being recognized by the police and tax authorities or in other words - free advice for clever tax fraud
with higher levels of latency for a lot of money.
2.3.Conclusion
In conclusion, the current research will define the differences between tax avoidanceand tax
evasion, focusing on the Balkan Peninsula as a specific geographical area. A modern view of tax fraud
with higher latency will be presented using examples of frauds with higher levels of latency.
2
3. Legal methods oftax avoidance
3.1 Tax avoidance
Tax avoidance is a lawful minimization of tax liability through sound financial planning
techniques or in other words, tax avoidance is bending the rules of the tax system to gain a tax
advantage that the government never intended. 2It often involves techniques, accounting methods and
contrived artificial transactions that serve little or no purpose other than to produce a tax advantage.
There is no doubt that tax avoidance is a legal method for decreasing the tax amount. However, it is
my opinion that tax avoidance is like a coin with two sides, a legal and illegal side. The legal side
involves an exemption method proclaimed in the VAT Directive ( article 138(1) ) or in other words
increasing export trading as a method of using the rights granted by the VAT Directive based on zero
rate of exports to a member state. Exemption appears when a business company makes an intracommunity supply of goods to another business company registered in another EU Member State that
met the conditions proclaimed in article 9 of the VAT Directive for a taxable person. Intra-community
supply is a transaction in which goods are dispatched or transported by (or on behalf of) the supplier or
the customer from one EU country to another EU country. Although, an intra-community supply is
normally exempt, the input VAT incurred on goods and services used for the purposes of making that
supply may be deducted by the supplier according to article 169(b) of the VAT Directive.3 This is
because the corresponding acquisition is taxed. For instance, a Bulgarian electronic manufacturer
supplies electronic devices to a business customer in Romania for use in a Romanian factory in
Bucharest. The Bulgarian company’s supply is exempt from Bulgarian VAT as an intra-community
supply. However, the input VAT the Bulgarian company incurs is deductible. The Romanian company
makes an intra-community acquisition of goods, which is subject to Romanian VAT.
3.2 Value Added Tax and methods of VAT Computation.
The definition of VAT is the tax on the value added at each stage of production – distribution
chain. Value added is equivalent to the sum of wages to labor and profits to owners of the production
factors including land and capital. 4 On the other hand, value added is simply measured as the
difference between the value of output and the cost of inputs. The most common method of VAT
computation is the invoice-based credit method. Under it, a company at any stage of production –
distribution charges its customers the VAT in its outputs, submits the tax to the treasury and then
claims for the VAT already paid on its input purchase. 5 The invoice-based credit method has
advantages in comparison with the subtraction method and addition method, which briefly
2
The General theory of tax Avoidance by Joseph E. Stiglitz, working paper N:1868, march 1986
VAT Directive, article 169(b)
4
The Anatomy of the VAT working paper by Michael Keen, May 2013
5
Article on consumption tax trends 2012, VAT/GST and excise rates, trends and administration issues, OECD
2012
3
3
requiremore accurate calculations and an explicit estimation of the tax base. Hence, under the invoicebased credit method, the VAT on outputs and inputs is essentially assessed and collected separately
and the refunds are credited on the basis of the invoice of input purchases. In other words, in a credit
method VAT, registered businesses (registered traders) assess tax on taxable goods and services
eachtime they supply such a good or service to either a business or a consumer. 6 Moreover, it is not
necessary to calculate the tax base, which could be taken as an advantage. An extra benefit of this
method is that it requires companies to retain invoices and consequently self improves the general
record keeping practice. Registered companies are permitted to reduce the amount of VAT they are
liable to remit to the tax authority by a credit equal to the amount of VAT paid to other registered
companies in purchasing business inputs (such as intermediate goods, services, fuel, plant and
equipment and the like) The credit eliminates the VAT on goods and services used by a registered
company, but remains in place of the VAT on sales to the final consumer7. This method ensures that
the consumption of all goods and services subject to VAT will be taxed once, generally at the
consumer level, which leads for VAT categorization as an indirect tax, because of that the person who
is liable to pay the tax (the business) is someone other than the person who actually bears the cost of
the tax (the final consumer)8 Presumably, a more precise description of the credit-invoice method is as
a “transactions-based, accounts-verified” tax, because while the tax is assessed on each individual
transaction, tax remittance to the tax authority is calculated and audited based on accounts.9
3.2.1 The Subtraction Method vs. Invoice-Based Credit Method.
The key difference between the subtraction-method VAT proposals and extant credit-invoice
method VATs is that the former generally do not impose an invoice requirement. 10 Many analysts
view lack of an invoice requirement and even the lack of verification as to whether a supplier is a
registered tax person (according to Article 9 of the VAT Directive) as essential characteristics of the
subtraction-method VAT.11 One of the main features of the subtraction method is referred to as
a
12
business transfer tax, which is less descriptive than that of a credit method VAT . As a result, the
subtraction method is described as being “account-based”, rather than “transaction based”, and is
commonly perceived to be a tax on specific goods and services.13 It could be argued that any open
subtraction-method VAT would be amenable to significant tax avoidance, as a result of deductions by
6
Although some VAT regimes recognize a legal distinction between the terms "sale" and "supply," they are used
interchangeably in this Article.
7
Sijbren Cnossen, Evaluating the National Retail Sales Tax from a VAT note 7 page 9
8
Consumption tax trends 2012 VAT/GST and excise rates, trends and administration issues – OECD 2012
9
Sijbren Cnossen, VAT Coordination in Common Markets and Federations: lessons from the European
experience, 63 Tal[ L. Rev. 583 (2010)
10
http://scholarship.law.georgetown.edu/cgi/viewcontent.cgi?article=1913&context=facpub
11
http://archive.gao.govf d25t7/138940.pdf (describing the absence of an invoice requirement as the essential
characteristic of a subtraction-method VAT)
12
http://scholarship.law.georgetown.edu/cgi/viewcontent.cgi?article=1913&context=facpub
13
Michael Keen – The modern VAT 21 (2001)
4
purchasers that are not offset by corresponding inclusions by sellers. Another issue with significant
importance might arise because the VAT is a tax on consumption, which means that financial
transactions are excluded. Hence, VATs do not require inclusion of interest or dividends received and
do not provide deductions for interest paid. Thisfeature could make the tax economically efficient
andis also an important reason for tax simplicity. Taking into account both features – efficiency and
simplicity of the VAT, requires drawing a huge distinction between “real” and financial transactions.
Taxpayers would find it easy to manipulate that distinction to their advantage in an open subtractionmethod system, which once again may lead to tax avoidance as a final result. However, this method is
less suited to deal with differential rate structures. Of the OECD countries employing VAT, only
Japan uses the subtraction method. 14
3.3. Destination Principle versus Origin Principle. Which principle influences tax avoidance?
The main purpose of VAT is to tax the final consumer. 15The fundamental issue of economic
policy is whether the levy should be imposed by the jurisdiction of origin or destination. Under the
destination principle, the tax is ultimately levied on the final consumption that occurs within the taxing
jurisdiction. However, under the origin principle, the tax is levied in the various jurisdictions where
value is added. The application of the destination principle achieves neutrality in international trade, as
exports are exempt from refund of input taxes, and imports are taxed on the same basis and at the same
rates as domestic supplies. In other words, if Bulgarian company X supplies sugar to a Serbian
customer in Serbia, this supply will be taxed in Serbia according to the Serbian VAT rate for those
kinds of goods – 10% VAT. 16 By contrast, under the origin principle each jurisdiction would levy the
VAT on the value created within its own borders.
17
Under an origin-based regime, exporting
jurisdiction would tax exports on the same basis and at the same rate as domestic supplies, while
importing jurisdiction would give a credit against their own VAT for the hypothetical tax that would
have been paid at the importing jurisdiction’s own rate. Under the origin principle the tax revenue is
shared amongst jurisdictions where value is added. However, the origin-basis VAT could lead to
significant tax avoidance. Taxpaying business would be able to deduct purchases from foreign
businesses that do not pay VAT. Thus taxpayers could claim deductions that would not be offset by
corresponding inclusions by other taxpayers. An origin-based VAT thus could create the same types of
asymmetries that arise domestically in an open subtraction-method VAT. 18The asymmetry may arise
with respect to related foreign parties, rather than just nonregistered domestic individuals and small
businesses. The scope of tax avoidance may be much more severe, because the range of entities that
14
Consumption tax trends 2012 VAT/ GST and excise rates
Consumption taxes: the role of the value-added tax, chapter 12, Satya Poddar
16
http://www.worldwide-tax.com/serbia/ser_other.asp
17
Consumption tax trends 2012 VAT/ GST and excise rates
18
Consumption taxes: the role of the value-added tax, chapter 12, Satya Poddar
15
5
can act as counterparties for avoidance transactions is broader. On the other hand, those transactions
could be easier to arrange and enforcement of anti-abuse rules is likely to be more difficult. 19
3.4.Exemptions Provided by the VAT Directive
VATs typically provide three different types of exemptions. 20 First supplies of goods and
services provided by public and government entities, as well as nonprofit organizations, charitable
organizations and similar tax-exempt entities are often exempted from the VAT for administrative,
distributional or other policy reasons. 21 Second, for similar reasons, specific goods and services (for
instance “merit goods” like educational service and health service) may also be exempt from the VAT
regardless of the nature of the entity that makes the supplies. Finally, small business may receive
entity exemptions in recognition of the constraints on their administrative capacity. On the other hand,
VATs do provide similar treatment, by offering refunds of input tax paid with respect to supplies that
are not taxed. This mechanism is known as “zero-rating”, which means that, while VAT is charged at
a zero rate on the supply of goods or services, the supplier remains entitled to claim input tax credit for
input tax incurred in making that supply, and therefore may be eligible for a refund of input tax paid.
This section, however, deals only with certain issues that arise generally in relation tothe provision of
an exempt good or service, so-called exempt supplies.
3.4.1 Exemptions for Triangular Transactions
A triangular transaction is a transaction in which a business established in a EU country
supplies goods to a customer in country B, but the goods are shipped directly to the customer from a
third country C. The word “triangulation” seems to stem from a certain way of depicting chain
transactions involving three parties. The triangulation scheme is straggling over three provisions in the
VAT Directive: articles 42, 141 and 197 VAT Directive. 22The triangulation scheme takes place for
instance when a business in Greece receives an order for shoes from a customer in Romania. The
shoes are made on behalf of the Greek supplier by a manufacturer in Bulgaria, who ships them directly
to the Romanian customer. Consequently, there are two intra-community supplies and one intracommunity acquisition. The Bulgarian manufacturer makes an intra-community supply of goods to the
Greek business, the place of this supply is Bulgaria (Article 32 VAT Directive). The Greek business
makes an intra-community acquisition of goods in Romania (Article 40 VAT Directive) The Greek
business makes a local supply of goods to its Romanian customer. The place of that local supply is
Romania (Article 31 VAT Directive). Under the normal rules, the Greek business would have to
19
http://scholarship.law.georgetown.edu/cgi/viewcontent.cgi?article=1913&context=facpub
Consumption taxes: the role of the value-added tax, chapter 12, Satya Poddar
21
Council Directive 2006/1 12, art. 132,2006 O.J. (L 347) I (EC) Ihereinafler EU VAT Directive
22
VAT Directive, article 42, 141 and 197 - https://edubb.uvt.nl/bbcswebdav/pid-1212525-dt-content-rid3518903_1/courses/600336-2015-2016/Directive%202006.112.EC%20-%20Consolidated%20version.pdf
20
6
register for VAT in Romania, where it makes the intra-community acquisition and account for
Romanian VAT on that acquisition and on its supply to the Romanian customer. However, under the
simplification rule in Article 141 VAT Directive, the intra-community acquisition made by the Greek
is exempt with the right of deduction, provided that the Romanian customer is registered for VAT in
Romania and is liable to account for VAT on the supply to him. Since the acquisition is now
exempt,the Greek business does not need to register for VAT in Romania in respect of that triangular
transaction.
3.4.2. Exemption Related to International Transport.
The grants provided by the VAT Directive includes also exemption with respect to
international transport services involving both goods and passengers. The exemption is reserved only
for international air and sea transport, however it does not apply and cover rail and road transport or
domestic air and sea transport. This becomes explicit from Article 148 VAT Directive. Hence,
International air and sea transport can benefit from the exemption proclaimed in Article 148, from tax
point of view.
3.5 VAT Grouping Allows Tax Avoidance – European Commission versus Business
3.5.1 VAT Grouping and Commission View
According to article 11 VAT Directive, two or more persons established within a member
state, who, while legally independent, are closely bound to one another by financial, economic and
organizational links, may be treated as a single person for VAT purposes. 23 In most member states,
where grouping exist, the effect is to allow related legal entities to make inter-company supplies of
goods and services without charging VAT. For those companies that can recover VAT in full, this can
23
VAT Directive, Article 11
7
ease cash flow or allow the offset of VAT payments and credits. However, for the business that make
exempt supplies such as those in the financial an insurance sectors, VAT grouping is far more
significant as it could prevent the addition of irrecoverable VAT cost to charges made between group
members. However, article 11 VAT Directive limits the formation of VAT grouping to the territory of
a single member state. The Commission opinion is that VAT grouping schemes adopted by
memberstates in their national legislation should only include taxable persons who are established in
the relevant member state and not their establishments, which are situated in overseas territories.
Respectively, only businesses with their seat of economic activity or the fixed establishments of such
business physically present in the territory of the member state may join a VAT group in that member
state. 24 This opinion, should be motivated of the fact that including foreign establishment to the
particular VAT grouping, in which the corresponding Head office is included may lead to VAT
exempt supplies between the foreign fixed establishment and VAT grouping as a whole, which
undoubtedly leads to significant tax avoidance. This is, for instance, the case where a fixed
establishment abroad “supplies” services to a group company, other than its head office, that is part of
the same VAT group to which the Head office belongs. Should this group company not be fully
entitled to deduction of input VAT if it was not part of the VAT group, supplies would be a cost for
that company. However, if the company is part of a VAT group and the foreign establishment as well,
the supplies by the foreign establishment and the company are not subject to VAT. In this scenario,
there is a VAT advantage, which could possibly be considered as tax avoidance by the Commission.
Furthermore, in its 2009 Communication on VAT grouping, the European Commission has taken the
position that this might even be regarded as tax evasion. 25Consequently, this means that in the view of
the Commission, when a taxable person joins a VAT group, any services it subsequently supplies to its
overseas establishments should be regarded as supplies made between two separate taxable persons,
irrespective of the conjoined legal status of the two establishments.
3.5.2. The CJEU View versus European Commission
One of the main cases that could be described as a controversy point against Commission
opinion is FCE Bank, where the CJEU confirmed that a head office and its fixed establishment are
both part of one and the same taxable person. 26 Briefly, the case concerned the supply of services
from the head office of a UK bank, FCE Bank to its branch in Italy – FCE IT (the services consisted of
management, consulting, data processing, employee training) and the supply and management of
software. The case has been referred to the CJEU, which held that a fixed establishment, which is
established in another member state and to which the head office provides services is not a legal entity
distinct from the company of which it forms part, and should not be treated as a taxable person by
24
http://taxinsights.ey-vx.com/archive/archive-articles/eu-vat-grouping-provisions-update.aspx
http://taxinsights.ey-vx.com/archive/archive-articles/eu-vat-grouping-provisions-update.aspx
26
CJEU case law, FCE Bank, judgement from 23 March 2006
25
8
reason of the costs imputed to it in respect of those service. 27The judgment has confirmed that
intra-community supplies of servicesbetween a lead office and a branch belonging to the same
legal entity, or between different branches of the same legal entity are not supplies for VAT
purposes. 28 Consequently, this ruling could lead to significant implications for international
companies operating in exempt sectors, as it potentially removes additional costs from cost
recharges between parts of the same legal entity located in different member states.
3.5.3. Full Application of FCE Rules to Overseas Supplies by The Netherlands and UK
UK and The Netherlands legislation allows overseas establishments of a VAT group
member are treated as being part of the VAT grouping. Hence, if an overseas establishment of
entity X supplies service to entity Y, where Y is in VAT group with entity X, the supplies will be
disregarded for VAT purposes. 29 It should be taken into account that in the UK there is an antiavoidance provision, which ensures that services bought by X to make the supply to Y are not
disregarded (and are therefore taxed)30 Presumably, in the Netherlands, the practical application of
such structure could be seen as tax avoidance as well by the tax authorities. Moreover, the strict
tax legislation in The Netherlands could take such structure even as tax evasion, as the
abovementioned supplies would be VAT exempt, which cause revenue losses from government
point of view.
3.5.4 VAT Advantages Could lead to Tax avoidance or Tax Evasion
VAT advantages are always welcome to the business. However, those advantages are
respectively disadvantages for the tax authorities. This is probably quite understandable from the
business and tax authority points of view. For instance, allowing a foreign head office and its local
fixed establishment to be a member of a VAT group, may lead to unintended VAT advantages, in
case there is no full right of recovery of input VAT. This could be described easily with a simple
example: if head office of a financial or insurance company purchase goods and services in a
country where there is no VAT system in place (like the US or India) and onwards supplies these
services to its fixed establishment in an EU country, while the head office and its fixed
establishment are part of the same VAT group, those services can be distributed to other members
of the VAT group without VAT. It could be argued that such unintended VAT advantages are
27
Judgement of the court (Second Chamber) in case – C-210/2004, FCE Bank plc/
http://taxinsights.ey-vx.com/archive/archive-articles/eu-vat-grouping-provisions-update.aspx
29
http://taxinsights.ey-vx.com/archive/archive-articles/eu-vat-grouping-provisions-update.aspx
28
30
HMRC General Anti Abuse Rule (GAAP) guidance https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/399270/2__HMRC_GAAR_Guid
ance_Parts_A-C_with_effect_from_30_January_2015_AD_V6.pdf
9
unjustified VAT advantages which could be regarded as “tax avoidance”, “tax evasion” or even as
“tax frauds”.
3.5.5. Conclusion
VAT grouping could be regarded as an area of endless focus for the European
Commission given the varying interpretations of CJEU rulings by different member states and the
consequent lack of uniformity in their adoption. Nevertheless, this could lead to some distortions
of competition between those member states that allow services to be supplied VAT – free in all
cases and those that impose a VAT cost on partly exempt group companies operating in their
territories. Notwithstanding, VAT grouping provides an objective and justified argument that the
difference between lawful ways to avoid paying taxes and unlawful methods is once again very
small and could lead to tax avoidance or tax evasion. It depends on the point of view that has been
taken to determine particular activities as attempts at lawful tax avoidance or illegal tax evasion.
3.6 The idea behind tax avoidance.
Tax avoidance is an entirely legal method of reducing the tax amount, when the business takes
steps to minimize its tax bills. It is more like bending the rules rather than breaking them. Usually,
companies pay a lot of money for tax and legal advice based on loopholes in the law and tax
legislations to minimize tax bills. Tax experts sit behind every method of tax avoidance. The term
could be described not only as a legal method of avoiding taxes, but also as a mechanism based on
copious tax knowledge and accounting tricks, which illustrate the reduced and desirable amount of the
tax bill. The last is a mirror of accountants and tax advisors efforts for achieving a lower tax
amount.Nevertheless, tax avoidance could be defined as using legal means to pay the least possible
amount of tax and definitely as opposed to tax evasion, which involves using illegal methods and very
often-committing fraud as an attempt to avoid paying taxes as a whole or to significantly reduce the
amount. 31In this occasion, governments around the world take an increasingly strong line to frustrate
schemes, which may break no laws at the time they are created, but use those laws to produce
outcomes, which the legislators never intended. Essentially, the main difference between avoidance
and evasion is simply called legality. Tax avoidance is legally exploiting the tax system to reduce
current tax liabilities by means not intended by the government and it often involves fake transactions
that are contrived to produce a tax advantage. In other words, every legal method or attempt at paying
lower taxes that had been acquired by the tax authorities, breaking its rules could be defined as tax
avoidance. The most usual examples of tax avoidance are tax exemptions based on the VAT rules that
have been mentioned above, however, the scope of VAT Directive is very broad with a lot of
examples and exemptions. Changing the business structure through incorporation or establishing an an
31
The General theory of tax Avoidance by Joseph E. Stiglitz, working paper N:1868, march 1986
10
offshore branch in a tax haven is also a way for tax avoidance, using the benefits provided by those
areas on the planet simply called tax havens. However, tax avoidance requires advance planning.
Almost all tax strategies are based on structuring the transaction to obtain the lowest possible marginal
tax rate by using a few tax strategies such as maximizing tax deductions from exports trade policy and
tax credits from previous purchases, or controlling the timing of income. Furthermore, tax avoidance
is not the same as tax planning or mitigation. Tax planning is conduct which reduces tax liabilities
without going against the government, for instance, through gifts to charity or investments in certain
assets which qualify for tax relief. 32However, one could argue the opposite, taking into account that
tax avoidance and mitigation are the same thing in principle, as one acts so as to minimize his/her tax
bill within existing legal structures. Notwithstanding, tax avoidance from the VAT point of view is the
process whereby an individual plans his or her finances so as to apply exemptions provided by tax law
and legislation to reduce taxable income. Through tax avoidance, an individual takes advantage of all
legal opportunities to minimize his or her income.
3.7.The Difference Between Tax Avoidance and Tax Evasion
Tax avoidance must be distinguished from tax evasion, which is the employment of unlawful
methods to circumvent the payment of taxes.
33
Basically, tax evasion is a crime, however tax
avoidance is not. Moreover, tax avoidance is legally reducing tax liability, while tax evasion is
illegally reducing tax liability based on fraudulent activities. Furthermore, tax evasion is a criminal
offense under state statutes. A person who is convicted is subject to a prison sentence, a fine or both.
Tax evasion could be any international or domestic fraudulent attempt to escape payments of taxes in
whole or in part. Tax evasion is an activity commonly associated with the informal economy. 34 One
measure of the extent of tax evasion is the amount of unreported income, which is the difference
between the amount of income that should be reported to the tax authorities and the actual reported
amount. However, both terms can be viewed as forms of tax noncompliance, as they undoubtedly
describe a range of activities that intend to subvert a state’s tax system. Nevertheless, tax avoidance is
a lawful method of subverting a state’s tax system. If we presume that avoiding paying taxes is a
game, everyone knows that one can play fair or unfair. In every single game is allowed using the
wiliness, cleverness and inventiveness, one should only keep the rules and play fair. If the business
plays fair trying to reduce the tax compliance, the activity is tax avoidance, however if the business
does not play fair is tax evasion. The effects cost by the last term are distortive from every point of
view, because the main source of funds for every state’s system is taxes. However, what is the
difference between tax evasion and tax fraud? Are they synonyms or independent terms in the field of
tax law and taxation? Tax evasion occurs when the taxpayer “forgets” to declare part of his/her
32
Information via web page: www.morrowInvest.com
The General theory of tax Avoidance by Joseph E. Stiglitz, working paper N:1868, march 1986
34
Information via web page: www.morrowInvest.com
33
11
income, which is a violation of the law, subject to administrative sanction.35 On the other hand, tax
fraud is any effort for reducing the amount of tax payable by means of a false declaration of income or
false increasing the expenditures by including artificial invoices of unreal transactions, which is a
criminal offence. 36 Probably a good example of distinction between both terms is the Swiss tax
legislation. Swiss fiscal law is essentially based on self-declaration of income and asset values. In the
case of tax evasion, the particular tax payer omits to declare circumstance with respect to his/her
income or trade policy, for instance by incorrectly or partially completing the tax return. In
comparison to most countries, Switzerland does not regard this behavior as a criminal offence and
rather it treats tax evasion as an infringement of the law punishable by a fine. 37However, any activities
that can be regarded as a tax fraud are liable to criminal prosecution in Switzerland. Notwithstanding,
most of the countries in the world treat both tax evasion and tax fraud as tax crime, including also false
tax return, filing false document, failure to collect employment taxes, failing to file a tax return or
using the artificial invoices.38 Generally tax fraud or tax evasion involves an intentional wrongdoing.
Usually, mere negligence is not a tax fraud. Very often tax frauds are committed by organized crime
group with strong pyramidal and hierarchical structure. Tax frauds are crime with a higher level of
latency. Basically, people who “pull the strings” are on the top of the pyramidal structure,
consequently they are “in shadow” for the tax authorities and police tax investigators. Nowadays, a lot
of techniques do exist, which facilitate committing tax frauds. Using those techniques and loopholes in
tax legislations one could easily create a fraud for a lot of money with higher levels of latency, which
could lead to its nondisclosure by national authorities and departments.
3.8. Real Movement of Goods versus Fictitious Exports.
A simple example could be taken into account to describe the advantages of exports] trade
policy based on “zero rate”. Bulgarian company “X” has bought goods from a Bulgarian producer for
10 000E and immediately has resold them to a Romanian company “Y” for 15 000E, the Bulgarian
company “X” receives a cash payment with amount of 3000E, as the goods have left the border
without VAT. Consequently, the Romanian company “Y” is liable to pay only 12 000E to the
Bulgarian company “X”, as the goods are VAT exempt. This is a perfect scheme for a business
distributor – buying goods from a producer and reselling them to a foreign company registered in a
member state. The advantages of this scheme is that the Bulgarian company “X” receivesa tax credit –
3000E. The expenditure for the abovementioned Bulgarian company “X” is the purchasing price – 10
35
Understanding taks evasion dynamics – working paper by Eduardo M.R.A. Engel and james R.Hines, Jr,
available on web page: www.nber.org/papers/w6903
36
Fighting VAT fraud: The Bulgarian experience, working paper written by Dr. Konstantin Pashev, June 2006
37
http://www.internationaltaxreview.com/Article/3167155/Tax-evasion-The-evolution-of-the-Swiss-CriminalTax-Law.html
38
http://www.internationaltaxreview.com/Article/3167155/Tax-evasion-The-evolution-of-the-Swiss-CriminalTax-Law.html
12
000E, the clear profit from the deal with company “Y” is 3000E / as the goods leave the Bulgarian
border with 0 VAT rate /. However, the Bulgarian tax authority recovers the VAT amount of 3000E
that has been removed. Hence, being an intermediary provides a tax advantage from VAT point of
view and the rights provided by the VAT Directive, especially with respect to exemption transactions
between member states based on zero VAT rate of goods leaving seller’s border. However, sometimes
the business makes fictitious exports of goods to another member state with aim to receive a tax credit
by the tax authority and to realize those goods on domestic market. Hence, those domestic deals will
be hidden to the tax authority as officially the goods are (fictitious) delivered in another member state.
In other words, the realized profit on the domestic market will be hidden to the tax authority without
any tax consequences to the business. Using the abovementioned example, implementing the second
scenario with respect to the export deal between companies X and Y, the last company will be liable to
pay Romanian VAT, even though the deal is fictitious. Very often, the company that makes intracommunity acquisition is fake and accumulates significant tax obligation to the tax authority, which
leads to tax verification by tax authorities and consequent criminal offense by the police department.
Those verifications take time which leads to difficult and rather slow communications between both
(Bulgarian and Romanian in the particular case) tax authorities. It could be argued that using the
abovementioned example (the second scenario) could be seen as tax evasion in Bulgaria by the
Bulgarian tax authority and tax fraud by the Romanian authority. Presumably, some could dispute that
both companies participate in the same fraudulent scheme, however it is rather difficult to prove those
kinds of arguments as usually the real company (company X in the particular example) does not know
that its customer is artificial, providing various documents and evidence in order to defend its
arguments and deals whichit has made.
3.9.Value Added Tax as a Tax Law
VAT does not follow many of the same principles of income tax or corporate tax and it has
vagaries to threat itself different subjects, goods and components how and when to tax.39 With the
correct VAT treatment of supplies sometimes appearing to have been determined on a purely
whimsical basis, many businesses spend an eternity just trying to maintain compliance with the basic
rules and never reach the enviable position as little VAT as they are required to by law. 40However,
many others have sought to the push limits of the VAT rules, with varying degrees of success. For
instance, Halifax set the precedent for VAT planning when they contrived a structure that eventually
enabled the bank to effectively reclaim VAT on expenses that related to wholly exempts supplies.
Although each individual transaction in the chain worked on a fundamental basis, HM Revenue &
Customs (HMRC) and the CJEU has taken a dim view of the structure and disallowed the VAT
39
40
The Anatomy of the VAT working paper by Michael Keen, May 2013
Consumption taxes: the role of the value-added tax, chapter 12, Satya Poddar
13
reclaim on the basis that the whole structure was artificial. 41 Furthermore, many years before the
General Anti-Avoidance Rule (GAAR) has been first muted, VAT had its own self-administered antiavoidance rules, which means that presumably Halifax could be seen as the starting point for
determining whether any structuring is deemed to be avoidance and is off quoted by HMRC as a
deterrent.
3.10. Zero Rated Exports Are of Massive Significance for Any Kind of Fraudulent Behavior
Furthermore, under “the destination principle” – commodities are taxed by the jurisdiction in
which they are consumed, which basically is the fundamental principle for VAT as a consumption
tax. 42 This is generally implemented under the VAT by zero-rating export and charging VAT on
imports, and nevertheless, intra-community supplies and acquisitions. While this implies that exporters
will be due refunds, it does not amount to an export subsidy and is fully WTO consistent: it is simply a
device for removing any domestic VAT from exports. On the other hand levying VAT on imports
simply puts them on the same basis as their domestically produced counterparts. Consequently, zerorating simply means that VAT is levied at a rate of zero: no tax is due on output, but the credit –
which, with no output tax, becomes a refund – is still available for input VAT. Being part of the EU, it
incentivizes the business to focus on export trading policy, which could lead to tax advantages.
However, “zero rated” exports are of massive significance for any kind of fraudulent behavior which
could go through from tax avoidance to tax evasion or even fraud. 43
3.10.1 Export subsidy provided by VAT
There is an objective argument about how VATs operate with respect to imports and exports.
VATs are usually destination-based in their treatment of trade flows. Firstly, in becomes explicit that
export trade policy provides cash – flow advantages.44 While a company’s VAT base is sales minus
purchases from other businesses, sales means sales to domestic businesses or consumers. Equivalently,
the base is total sales net of exports minus purchases from other businesses. In other words, tax
liability is the tax amount from total sales minus tax amount of previous purchases that have been
made from other businesses, minus the tax amount of realized exports in case of consequent deals with
a foreign company. Hence, it certainly looks like VAT contains an export subsidy. This mechanism
could influence tax evasion and committing tax frauds. Furthermore, it is not difficult for one taking
into account the abovementioned to conclude that a company could make a fictitious export to a
foreign customer and to realize the production (goods for example) in the home market. This scheme
provides two sides of advantages. Firstly, the tax authority refunds the VAT amount based on the
41
Halifax: a redefining moment in law, article available on http://old.tax.org.uk/attach.pl/4377/4446/024025_TA_0406.PDF
42
Consumption taxes: the role of the value-added tax, chapter 12, Satya Poddar
43
Fighting VAT fraud: The Bulgarian experience, working paper written by Dr. Konstantin Pashev, June 2006
44
Consumption taxes: the role of the value-added tax, chapter 12, Satya Poddar
14
export. Secondly, as the goods are being realized in the domestic market in normal circumstance the
seller should pay VAT on the realized profit. However, officially the goods are exported to a foreign
country, so they remain hidden from the tax authority. Nevertheless, the VAT destination principle
influences committing international tax frauds as the final company in local group of companies
makes exports and receives the VAT amount by the tax authority. Moreover, some experts claimed
that an “idealized” VAT that promotes exports is neither pro-competitive nor anticompetitive. 45 What
idealized means is that VAT applies uniformly to all goods and services. In practice, this is not true
because of the non-coverage of some goods – either by design or difficulty of administration – or
because of differentiated rates applying to a non-uniform VAT may indeed affect the size of the traded
goods sector. Real world VAR regimes tend to offer more favorable treatment to non-traded goods
such as services (for example owner-occupied housing and medical services)46 A VAT that is nonuniform because it favors non traded goods and hence levies a relatively higher tax rate on tradable
goods, with the effect of increasing non-tradable consumption and production at the expense of
tradable goods. Imports and exports are both reduced by such a non-uniform VAT.
3.10.2. Conclusion
It could be concluded that VAT promotes exports providing tax advantages for local business
to focus on exports trade policy. Moreover, the VAT system by member states, as an indirect tax on
final consumption means that the tax burden is taken by the final customer, which undoubtedly
encourages business to perform export trade, deducting VAT on their previous purchases and
refunding VAT on their exports as a basic requirement according the VAT Directive, which has
already been discussed in the previous sub chapters. This is the lawful way to reduce the tax burden
which illustrates legal tax avoidance.
3.11. Avoiding VAT registration
The most common such cases under the VAT are relatively small businesses operating close to
the level of turnover at which registration becomes compulsory, that fail to register, saving both VAT
for which they would be liable and VAT compliance costs. Every member state has an official annual
threshold for small business. For instance, in Bulgaria the threshold for VAT registration is
approximately 25 500E annual turnover for all traders. If a company is under this threshold it is liable
to pay only 10% tax on its income such as personal tax income. However, if this threshold is surprised
in any period of 12 months or less, then the company is obliged to submit an application for VAT
45
Article for VAT advantages available on: http://www.taxanalysts.com/www/freefiles.nsf/Files/SLEMROD14.pdf/$file/SLEMROD-14.pdf
46
Article for VAT advantages available on: http://www.taxanalysts.com/www/freefiles.nsf/Files/SLEMROD14.pdf/$file/SLEMROD-14.pdf
15
registration within 14 days of the end of the month in which the threshold was crossed. 47The basic
disadvantages of this situation is that the non VAT registered companies are not able to deduct VAT
on their previous purchases. However, they are liable to pay double, less the amount of VAT on their
monthly profit. Furthermore, the number of companies that have to be handled by the VAT
administration can be sharply reduced by setting a high turnover threshold. The VAT registration
threshold varies widely even within the EU, from 25 500E in Bulgaria to 61 000 pounds in the United
Kingdom. Outside the EU, some very high thresholds can be found, for instance 500 000$ in
Singapore. 48The revenue lost by setting a high threshold may be small compared to the saving of
administration costs to the authorities and compliance costs to the taxpayer, because the potential tax
base is commonly very strong concentrated in the largest companies. Moreover, companies not
registered for VAT face a non-zero effective rate of tax as they cannot reclaim the VAT paid on
inputs. Nevertheless, to be factored into setting the threshold, however, is the potential distortion that
any threshold creates in the competition between those companies that are above and below it, this
will eased by the possibility of voluntary registration, but it is by no means resolved whether the
appropriate response to this distortion is to set the threshold lower than would otherwise be
appropriate.
3.12.Tax avoidance via reverse charge mechanism
The VAT is a type of indirect turnover based tax that is levied during the final phase of the
purchaser of the goods and is included in the price of the purchased item or service.49 Being a turnover
tax, VAT is levied at each stage of production and the distribution process as well. Although liability
for the tax rests on the person who supplies or imports the goods or services, the real burden of VAT is
borne by the final consumer. 50However, this system can lead to a risk of “missing trader” fraud, where
the supplier evades paying to the State the VAT collected on sales while the customer has the right to
deduct VAT on the basis of a valid tax invoice. 51 This particularly involves trading of goods or
services between Member States with several supplies of the same goods or services without VAT
payment and where the “missing trader” exploits the break in the link in the chain which appears when
there is an intra-community supply. In order to tackle such fraud is the application of a so-called
“reverse charge mechanism”,52 where the customer becomes liable for the VAT on goods or services
supplied to him. Consequently, the customer is paying and deducting the VAT via the same VAT
47
http://www.tmf-group.com/en/media-centre/resources/vat-news/vat-country-profiles/vat-in-bulgaria
48
Value added taxation: Mechanism, design and policy issues – paper prepared for the World Bank course on
practical issues of tax policy in developing counties, Washington D.C, April 28- May1, 2003, written by Tuan
Minh Le
49
Consumption taxes: the role of the value-added tax, chapter 12, Satya Poddar
50
Consumption taxes: the role of the value-added tax, chapter 12, Satya Poddar
51
Fig6hting VAT fraud: The Bulgarian experience, working paper written by Dr. Konstantin Pashev, June 2006
52
Application of the reverse charge mechanism under article 199, 199a, 394 and 395 VAT Directive.
16
return within the limit of its VAT deduction rights. 53For instance: Bulgarian company “X” is a fully
taxable person according article 9 VAT Directive and supplies support service to the Romanian
company “Z”. The Bulgarian company “X” should issue a VAT invoice to the Romanian company
“Z”. Neither Bulgarian nor Romanian VAT should be charged on the invoice. VAT should be
accounted for in Romania, where the service is consumed by the Romanian company “Z”. Under EU
law, the Romanian company “Z” is required to self-account for the VAT due on its purchase of the
service via the reverse charge mechanism. The Romanian company should charge itself VAT on the
purchase via its Romanian VAT return. If it is entitled to recover the VAT is has charged itself, this
should be done in accordance with Romanian VAT Law. The effect to both (Bulgarian and Romanian)
tax authorities does not change, as the reverse charge mechanism is used. VAT is due in Romania, as
the services are consumed there. Under, VAT Directive, the Romanian VAT is accounted for to the
Romanian tax authority by the customer – the Romanian company “Z” rather than the supplier. The
sale is outside of the score of Bulgarian VAT as the services are consumed in Romania, hence no VAT
is due to Bulgarian tax authority. There is no net VAT cost to the Romanian company in this example
as the Romanian company “Z” is not the final consumer in the supply chain and is itself a fully taxable
business. The final consumer is the one that ultimately bears the VAT cost. Notwithstanding, some
member states are in favor of a “generalized reverse charge mechanism”, while others are opposed to
such mechanism of the risk of having the fraud shifted to the last stage of the distribution chain.54
3.13. Changing of Residence
An example of changing residence could be given as a method of tax avoidance. A business
company changes its residence to a country, which has a lower VAT tax rate or to a country without
any tax rates such as the Cayman Islands, which is known as a tax haven with its zero tax rate.
Usually, registered companies in tax haven areas pay a lower amount of taxes or do not pay any taxes
as a whole. One of the most important advantages of a registered company in a tax haven area is that
the name of its owner is a secret for national authorities and governments.
55
Offshore areas are
preferable for those companies, which export or import various goods. For instance, if an enterprise
registered in Bulgaria buys goods from a foreign company for 100 000E and it resells them in the
Bulgarian market for 200 000E, the Bulgarian company is liable to pay 20 000E VAT as the VAT rate
in Bulgaria is 20%. However, if the Bulgarian company spent those goods thorough its offshore
subsidiary and declare sales price with amount of 190 000E, but selling it on Bulgarian market for
200 000E, the Bulgarian company will have realized a 10 000E profit and will be liable to pay only
2000E VAT instead of 20 000E, which is 10 times less than the first scenario.
53
Assessment of the application and impact of the optional “reverse charge mechanism” within the EU VAT
system, final report made by Ernst and Young, November 2014, page 4
54
Assessment of the application and impact of the optional “reverse charge mechanism” within the EU VAT
system, final report made by Ernst and Young, November 2014, page 5
55
Narrative report of Cayman Islands, by financial secrecy index
17
4. Tax
Evasion
4.1 Tax Evasion - Definitionand Measurement
Taxation and evasion have always gone together.56 Tax evasion is the illegal avoidance of taxes by
individuals, business companies and trusts.
57
Usually, tax evasion entails taxpayers deliberately
misrepresenting the true state of their affairs to the tax authorities to reduce their tax liability and
includes dishonest tax reporting with fate statements, such as declaring less income, gains or profits
than the amounts actually earned or overstating deductions. One measure of the extent of tax evasion
is the amount of unreported income, which is the difference between the amount of income that should
be reported to the tax authorities and the actual amount reported.Furthermore, tax evasion is the
criminal act of using illegal means to avoid paying taxes. Tax evasion schemes are plentiful, but all of
them involve the misrepresentation of an individual’s or business’ income and/or assets when
reporting to the tax authority, in order to reduce the amount of taxes they owe. It is not a surprise that
corporations and powerful companies pay a lot of money for tax advisors and consultants, whom have
the obligation to reduce the tax amount that should be paid to the tax authorities. After all, tax evasion
is illegal, and individuals have strong incentives to conceal their cheating, given financial and other
penalties that are imposed on individuals who are found cheating on their taxes. 58 Moreover, a high
degree of tax evasion can sharply reduce the value of tax incentives and affect allocation behavior,
create artificial biases in macroeconomic indicators, which may lead to inappropriate policy responses,
retard attempts to monetize economies in developing countries and affect income redistribution.
59
Measuring the size of tax evasion could be useful because it might give to policymakers some ideas
and conclusions about the reliability of their policy analysis and the expected effectiveness of their
policy prescriptions. However, the direct measurement of tax evasion is inherently difficult, because
its illegal nature requires secrecy and because conceptual problems make it hard to define. 60 However,
the “traces” that tax evasion leaves can be analyzed and to some extent measured by experts and
investigators.
56
Tax evasion and experimental approach by Paul Webly, Cambridge University press
Tax avoidance, evasion and administration by Joel Slemrod and Shlomo Yitzhaki, working paper 7473 of
National Bureau of Economic Research, January 2000
58
Measuring, explaining and controlling tax evasion, Tulane economics working paper available on
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.335.3739&rep=rep1&type=pdf
59
Article for finance and development, 2000 Hell and Howell information and Learning Company.
60
Measuring, explaining and controlling tax evasion, Tulane economics working paper available on
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.335.3739&rep=rep1&type=pdf
57
18
4.2 Two Concept for the Link between Tax Avoidance and Tax Evasion.
4.2.1 The key differences between tax avoidance and tax evasion.
Knowing the differences between tax avoidance and tax evasion is quite important as
otherwise one could get himself/herself into legal trouble. The definition of tax evasion has already
been discussed in chapter 4.1. However, to put it briefly once again, tax evasion means taking illegal
steps to willfully avoid paying required taxes. In contrast, tax avoidance is the legal use of tax laws to
reduce one’s tax burden. Both tax evasion and avoidance can be viewed as forms of tax
noncompliance, as they describe a range of activities that intend to subvert a state’s tax system,
although such classification of tax avoidance is not indisputable, given that avoidance is lawful, with
self-creating systems. Furthermore, a planning made to reduce the tax burden without infringement of
the legislature is known as tax avoidance. An unlawful act, done to avoid tax payment is known as tax
evasion. Tax avoidance involves taking benefits of the loopholes in the law. Conversely, tax evasion
involves the deliberate concealment of material facts. The arrangement for tax avoidance is made prior
to the occurrence of tax liability; unlike, tax evasion where the arrangements for it are made
subsequent to the occurrence of the tax liability. The result of tax avoidance is postponement of tax,
whereas the consequence of tax evasion, if the assesse is found guilty of doing so, is either
imprisonment, penalty or both. In conclusion, the abovementioned simply means that tax avoidance is
taking advantages of laws that exist for reducing the amount of tax that needs to be paid. Those
companies which typically take advantage of this action do so legally by simply taking deductions or
changing their business, so that they incur fewer taxes. 61
4.2.2. Arguments Supporting the Concept of Non-Differentiation Between Both Terms
It could be argued that there is a concept that does not emphasize the differences between
evasion and avoidance. This is because both terms have the same economic effects on government
revenue, on taxpayers after tax-income, and on fiscal equity. Both can be considered alternative ways
of coping with high tax rates and both are interdependent because significant and well-known tax
avoidance could increase tax evasion. This conceptual issue could arise, because two estimates are
used as proxies for tax evasion: the estimate of the underground economy and that of tax
noncompliance. These two estimates are different because the former measures in at products that are
unaccounted for in official gross national products figures but the latter measures income unreported
or underreported in tax returns. Although both estimates deal with unaccounted income, one is
unaccounted for in the national income accounts, while the other for tax purposes.
61
http://www.lawbusinesssecrets.com/knowing-the-difference-between-tax-evasion-and-tax-avoidance/
19
.
4.2.3 Consequences of Overstepping the Difference between Avoidance and Tax Evasion
Tax evasion refers to the deliberate omission of income on a tax return, the nonpayment of
taxes owed or not filling a tax return altogether, to avoid having to pay taxes to the government. 62The
institution that is responsible to seek any attempts for tax avoidance or even committing tax frauds is
the national tax authority of every member states. If a particular domestic authority is informed that a
particular company has misrepresented the situation on its taxes, it will audit that company. During
this audit, if the audited company cannot prove that it can legally claim the credits and exemptions on
its return that had been already declared could lead to serious legal issues and problems. After the
audit the tax authority can signalize to the police economic department in case of facts or even
justified evidence for committed tax fraud by the audited company or its participation on it. To avoid
such problems the powerful companies constantly seek the assistance of an attorney or prominent tax
consultant right away. If a company has not actually committed fraud, but rather it’s actions show
similarities with the fraud’s features, an experienced attorney or tax advisor could help for keeping the
company’s owner from paying huge fines or even to keep them out of prison.
4.2.4. Conclusion
Tax avoidance and tax evasion are both meant to ultimately reduce the tax liability but what
makes the difference is that the former is justified in the eyes of the law as it does not make any
offense or break any laws. However, it biased as the honest taxpayers are not fools, but can also make
arrangements for postponing unnecessary tax. Overstepping the fine difference to reduce legally the
tax amount by lawful means and commit fraudulent activity that involves illegal elements is hence
punishable for its decreasing or hiding money refers to tax evasion, which leads to criminal offence.
4.3. Offshore Registration
Tax evasion is one of the reasons for offshore registrations. Of course, every single offshore
registration provides a wide scope of advantages such as an anonymous owner, no information with
respect to funds origin, money transaction, information about bank accounts and etc. Offshore
companies are preferable as a legal way of decreasing the tax burden. The local authorities / in the tax
haven areas/ only know who the manager is and information with respect to the company’s
registration. However, they do not have any information about the owner of the company’s business.
Usually, the registered offshore company is a stock company, whose shares are controlled by the
owner. 63 Offshore companies are appropriate for tax evasion or even committing tax frauds. For
62
Tax avoidance, evasion and administration by Joel Slemrod and Shlomo Yitzhaki, working paper 7473 of
National Bureau of Economic Research, January 2000
63
Narrative report of Cayman Islands, by financial secrecy index
20
instance: offshore company establishes an office in duty free zone in a foreign country. Hiring a
warehouse in that zone automatically could be used as evidence that the offshore company makes
business on the territory of the corresponding country, where the office has been established. The
importation to the warehouse is duty free. The local company imports from various destinations
without paying duties and levies, as the receiver actually is the offshore warehouse. In this scheme the
offshore company only realizes the import goods on the name of the company buyer. Consequently,
the money goes through the offshore area where the profit is realized and it is not being taxed. At the
end of the year, the gain goes to the owner as a dividend, which is not being taxed as well. However, it
could be argued that the abovementioned might be kind of discussion whether the illustrated scheme is
tax avoidance or it is definitely tax evasion as the example describes using a lawful method of
avoiding paying taxes provided by the offshore registration.
4.4 Schemes of Tax Evasion and Frauds
4.4.1 Accounting for the Less than Committed
In this scheme, traders declare only a fraction of sales that have been previously done, creating
false documents or documents with incorrectly contain in order to balance their accounts match or they
do not account for some of their sales to the customers, or sometimes they declare less income of their
sales by officially declaring less supplies than those that have been actually done. The benefit for those
traders is that they decrease the tax amount by hiding their real business activities, sales and profits.
4.4.2 Unjustifiably Claiming a Tax credit or Refund of Tax Paid
Tax evasion and frauds most distinctive to the VAT exploit are the crediting of tax paid on
purchased inputs against the tax due on sales and it is the zero –rating of exports that has proved the
feature most vulnerable to fraud, or at least which has proved especially attractive to deliberate
criminal attack.64 The difficulties with zero-rating exports is that it not only breaks the VAT chain but
does so “at a particular vulnerable spot: the interface of domestic and foreign tax authorities and their
administration. This definitely creates a number of possibilities for fraud. However, the best known
form of deliberate attack on the VAT system is the “carousel fraud” that has attracted such attention in
the EU over the last few years. 65
64
Fighting VAT fraud: The Bulgarian experience, working paper written by Dr. Konstantin Pashev, June 2006
VAT fraud and evasion: what do we know, and what can be done – IMF working paper by Michael Keen and
Stephen Smith.
65
21
4.5. Tax Fraud
4.5.1 Definition
Fraud takes place when a person deliberately practices deception in order to gain something
unlawful or unfairly. Tax fraud appears when an individual or business company willfully and
internationally falsifies information and documents on a tax return in order to limit the amount of tax
liability. 66Tax fraud entails cheating on a tax return in an attempt to avoid paying the entire or part of
the obligation or to receive a cash-flow payment by tax authority based on a declared fictitious export
to a member state. VAT fraud is influenced by the elimination of border controls on the flow of goods
and the expansion of trade in service as well as of e-commerce, which on the other hand embarrass the
administration of VAT in intra-community trade. 67Risk management and selection of audits required
much closer cross-border integration and cooperation between member states at all levels of law
enforcement, as the effort becomes much more international as the VAT collection in one member
state depends on the administrative efficiency of tax auditors in the trader’s partner country. 68This fact
shows that the combat against tax fraud is a European issue rather than a national one.However, the
complexity of the VAT system may hinder the functioning of the internal market. A simpler VAT
system not only reduces compliance costs to businesses but also facilitates compliance by business and
therefore contributes to reducing mistakes, tax avoidance, tax evasion and fraud. Usually, tax frauds
are committed by organized crime groups with very strong pyramidal structure, in which on the top of
it stay powerful people with a lot of money and positions in various institutions, which could influence
the particular fraud with so called way of “umbrella” – giving “protection”, which is a definite kind of
corruption. The tax fraud’s aim is illegal assimilation of tax amounts from tax authorities by using
false accounting documents and manipulating bank transactions. Very often, after the fraud’s
realization the money that has been received is being laundered in order to hide it’s origin.
4.5.2 The Mechanism of VAT fraud
VAT fraud is usually interpreted in two broad categories.69 The first one involves a wide scope
of techniques and mechanisms of conventional tax evasion. This is when a business company wants to
hide some of its sales in order to decrease the monthly overall tax amount to the tax authorities. This is
typical when a company does not issue an invoice regarding the particular sales to its customer.
Consequently, sales are not recorded in the accounting books, or are recorded at lower than actual
prices and quantities. Notwithstanding, conventional evasion could be effected through overvaluing of
spending inputs. However, both purposes are decreasing the tax liability stemming from real
66
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Fighting VAT fraud, The Bulgarian experience – working paper by Dr. Konstantin Pashev, June 2006
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Tax frauds and techniques for tax control by Dr. Boris Reshovski, article from 2008
69
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67
22
transactions. The second category includes methods of abuse of tax returns through fictitious
transactions and traders. It implies a net cash outflow from the national treasury, which is a result of
multistage paper transactions based on false documents between accomplices. This causes huge losses
to the treasury and it is of significant importance for every member state to prevent such criminal
activities. The distinction between tax evasion (hiding the tax liability) and siphoning of VAT credit
may seem elusive and a matter of scale rather than content. 70 In the final account it is the magnitude
of the fraud that determines whether the fraudster will end up with net cash inflow from the treasury.
Therefore a distinction between tax evasion through hiding of net revenues from real transactions and
organized abuse of tax credit through fraudulent networks based on fake transactions and artificial
companies should be made. The criminal network of tax frauds includes not only real and artificial
companies, but also depends crucially on the collusion by tax authorities, tax auditors, customs
officers and other law-enforcement authorities, which are responsible to detect and control such
fraudulent activities protecting the national treasury from criminal attacks. This makes network tax
fraud a type of organized crime rather than tax evasion. 71 Hence, combating it requires a different set
of instruments and methods, skills and close cross-border operation in investigation and prosecution.
This is because of the fact that most of the organized tax frauds include exports as a final stage
operation involving a company from another member state. The most common international ways of
abuse of the rights to VAT credit are fictitious export and the missing trader fraud. In the case of face
exports the exporting company carries the transaction only on paper, applying the zero VAT rate on
exports and claiming tax credit on the inputs, while actually selling the products on the domestic
market without sales invoices and logically without paying any VAT. A safer version would use real
exports, but would overstate the quantities exported. 72 The scheme’s success depends on the “cooperation” of a customer officer, who are liable to processes the paperwork on the export transaction.
Consequently, for achieving the fraudulent aim for international tax fraud very often involves bribery,
given to the customs or tax administration, which confirm the “truth” declared in the fake documents.
Therefore, it is not necessary only a strong structured network but rather co-operation by customs or
tax administration which is easily achieving in countries with official low standard of living like
Bulgaria and Romania. Hence, a fictitious export is more of a border type fraud between individual tax
evasion and network abuse of credit. Nevertheless, the replacement of physical border control with the
VIES system in intra-community trade eliminates the necessity of customs officer in the fraudster’s
network and makes this fraud an instrument in the missing trader fraud rather than stand-alone
scheme. 73 Nonetheless, Bulgaria becomes the land and the sea border of the EU in regard to Turkey,
70
Fighting VAT fraud, The Bulgarian experience – working paper by Dr. Konstantin Pashev, June 2006
Fighting VAT fraud, The Bulgarian experience – working paper by Dr. Konstantin Pashev, June 2006
72
Combating tax and benefit fraud – government of the Netherlands available on web page https://www.government.nl/topics/combating-tax-and-benefit-fraud/contents/vat-fraud
73
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23
which is non-EU country, the Western Balkans, Russia and the Asia cargos via Russia and Turkey,
which would increase the relative weight of such type of tax credit from EU point of view.
4.6 Typical Tax Fraud in the Balkan Peninsula
4.6.1 Carousel Fraud
European VAT is vulnerable to fraud. 74A simple way for a business to commit VAT fraud is
to charge VAT on an invoice, to collect the VAT from the customer, but not to remit that VAT to the
tax authorities.75 The customer will deduct the VAT on the invoice, as a result of which the member
state will miss out on the VAT revenue and will also incur a cost, because of the VAT it refunds to the
customer. With respect to the “carousel fraud” a special case of what is termed is created in the United
Kingdom called “missing trader intra-community fraud” (MTIC), which exploits the zero-rating of
exports combined with the deferred payment mechanism for collecting VAT on imported goods. 76It is
important to be taken into account VAT on imports from another member state is collected not at the
border but at the time of the next periodic return. This is because of the EU restriction adopted in 1992
between the member states, which abolish fiscal frontier formalities between traders from different
member states, as part of a wide-ranging package of measures designed to promote economic
integration between member states – the “single market” program. This involves, that member states
are not permitted to operate frontier formalities, including fiscal procedures, which could impede the
free of goods trade between them.77 As a result verification of the right to zero-rate goods exported
from one member state to another can no longer make any use of border procedures and must be based
on audit of documentary evidence from the seller and buyer. Member states are, however still able to
use frontier formalities to verify the export of goods outside of the EU. 78
4.6.2. Example of “Carousel Fraud” in the Balkan Peninsula
Company A is located and registered for VAT purposes in Greece, export goods to company B
located and registered in Romania. As a consequence of export zero-rating, company A receives a full
refund of any input VAT paid. The VAT-free unit price at which the goods have been sold is 10 000E.
Under the deferred payment scheme, company B is not required to pay VAT at the time of import, but
rather to account for this in its next periodic return. The applicable rate of VAT in Romania is 20%
and (for simplicity) that company B adds no mark up on its sale. Hence it will sell itto another
74
Fighting VAT fraud: The Bulgarian experience, working paper written by Dr. Konstantin Pashev, June 2006
VAT fraud and evasion: what do we know, and what can be done – IMF working paper by Michael Keen and
Stephen Smith
76
Internal tax revenue analyses - http://www.internationaltaxreview.com/Article/3223305/UK-Missing-traderintra-community-fraud-Are-businesses-really-prepared.html
77
Ainsworth, Richard T., 2006, “Carousel Fraud in the EU: A Digital VAT Solution,” Tax Notes International,
pp. 443–48
78
The single market strategy adopted by the European Commission - http://ec.europa.eu/growth/singlemarket/strategy/index_en.htm#retail
75
24
Romanian company C, charging it 12 000E, with 2 000E as VAT. 79The invoice issued to C entitles it
to a 2 000E credit against its own output VAT. However, at that moment comes the catch: company B
does not remit to the tax authorities VAT with amount of 2 000E that it has charged and invoiced –
instead, it goes missing without paying any VAT. The invoice issued by B continues its way down the
production chain, through company C and perhaps other “buffer” companies which are fully artificial
and unaware of the fraud being perpetrated – until it arrives to company D, which exports the goods
out of Romania. In doing so, company D obtains a VAT refund for an amount that includes the VAT
which company B did not pay. If these buffer companies also add no value, so that company D
purchases at a VAT – inclusive price of 12 000E, then the amount of the refund is 2 000E,
corresponding to the VAT that the importing company B invoiced but failed to remit.
Notwithstanding, in a pure carousel fraud, the export by company D takes the goods back to Greece,
presumably via third countries. The whole process starts again, with the goods – usually high value
items relatively cheap to transport, such as mobile phones or computer chips going round in a lucrative
circle.
79
http://ec.europa.eu/taxation_customs/resources/documents/taxation/vat/how_vat_works/rates/vat_rates_en.pdf
25
This fraud is a major threat to the EU VAT system.
80
Member states and European
Commission are keen to combat such fraud. Various legislative measures should be taken in order to a
“quick response” by tax authority and competent institutions, which could allow the rapid introduction
of reverse charge mechanism provided by VAT Directive in case of sudden and massive fraud. 81
4.6.3 “Missing Trader Fraud”
This is one of the most typical tax fraud in Balkan Peninsula, which involves a chain of paper
transactions at prices deviated from the market ones. This leads to accumulation of a large portion of
the VAT liability in a phantom undertaking, thereby making it uncollectable.82 This scheme must end
with a zero rate trader in order to actual cash flow out of the treasury to the fraudsters. In this occasion
the final trader – exporter makes intra-community supply to customer in another member state. It is
very important to be noticed that even in case exports are real, the value of inputs are so inflated that it
entitles the exporter to a large refund. The illegal refund of the VAT credit flows to a “legal” real
exporter before the tax administration discover that there is a missing trader up the chain. This missing
trader is being used as a buffer for accumulating higher amount of VAT, or with other words for
artificially increasing the price, because the tax liability depends on the price of respective goods and
services. On the other hand the missing trader is artificial company registered on the name of halfliterate individuals who live very low standards of life. A Bulgarian version of the missing trader
frauds is the insolvent trader fraud. 83 Instead of missing trader, which is easier to be detected by the
tax authorities before the refund is completed, this scenario uses existing real company, but before the
tax collector reaches it, it is already transferred on indigent or half-literate individuals without any
assets. Usually, they do not have property, living alone like bums or homeless people who live in
abandoned buildings. The “suitable” candidates for new business owners are people form gypsy
origin, who do not have even elementary education as they are not able to write and read.
Consequently, making transfer on those kind of people means that the tax obligation, which generally
is a huge amount is transferred on their names, hence they are liable to pay. Very ridiculous fact is that
in Bulgaria, according to Bulgarian national tax legislation, there is no restriction a company with
officially declared tax obligations to be transferred once or even many times on the names of different
people. This makes the proceeding investigation suchas nightmare, because according another absurd
tax law in Bulgaria, the tax authorities cannot provide any information and documents to the police
80
VAT fraud and evasion: what do we know, and what can be done – IMF working paper by Michael Keen and
Stephen Smith
81
Article 199b VAT Directive allows member states to reverse charge in identified sectors and for certain types
of transactions, and indeed they do so quite extensively
82
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officers with respect to audited company, which is object of investigation by the police officers. The
only possible way for achieving it is official permission written by the company’s owner attesting that
he/she allows any information regarding his/her company to be disclosed. A reserve way for urgent
situation is requiring of permission issued by the Administrative Court, which usually takes more than
5 months. In this period the fraudulent company could be transferred ones again or even more, which
invalidated the Court’s permission. 84
4.6.4“Missing TradersFraud”
This scheme is approximately the same like the abovementioned, however the main difference
is with respect to the missing trader, which is more than one. Usually, in the chain there are various
artificial companies registered on the names of half-literate people. The basic aim is artificial VAT
accumulation. For example: Company A is real business entity registered in Bulgaria dealing with
frozen sea products. The company has found a Turkish business entity deals with cheap frozen sea
products. If, company A directly buys goods from Turkey, the company will be liable to pay VAT of
its importation. However, an artificial company B controlled unofficially by company A makes
importation from Turkey for 100 000E and is liable to account 20% VAT on this purchase, which is
being included in the accounting statements for all purchases made by company B for the respective
period. The later act by company B is to resell the sea products to another artificial company C for 140
000E, which makes consequent deal and resells the production to another (artificial) company D for
170 000E. Finally, company A buys the sea products from company D for 200 000E and makes
consequent export to Romanian artificial customer – company Z registered in Romania. The latter act
is reselling the products by company Z to real company Y in Romania for 240 000E.
4.6.4.1 Tax Consequences in Bulgaria
Company B is liable to pay 20% VAT of 140 000E – 28 000E, however, it can deduct the
amount of 20 000E from its importation as a tax credit. Hence, the tax obligation is only 8 000E.
Company C is liable to pay 20% VAT of realized profit (the difference between purchase and sales) –
170 000E – 140 000E x 20% VAT = 6 000E. Respectively, company D is liable to pay – 200 000E –
170 000E x 20% VAT = 6 000E. As a result of export zero-rating, company A receives a full refund of
any input VAT paid. Company A receives 40 000E as a tax credit by Bulgarian tax authority.
4.6.4.2. Tax consequences in Romania
Company Z makes intra-community acquisition in Romania and has to self-account Romanian
VAT as the goods are bought with 0% VAT with consequent deduction. If company Y has bought the
goods for 240 000E is liable to use a tax credit with amount of 48 000E. Let’s presume that Company
84
The information is based on my own experience as a police investigator, all details and facts are officially
according Bulgarian tax legislation, rules and law as a whole.
27
Y has various shops in Romania for sea products and realized a profit of 270 000Efrom various sales
to private consumers. It will be liable to pay 270 000 x 20% VAT – 48 000 VAT tax credit = 6 000E.
This is the official scenario of the chain transaction. However, the real deals are completely different company A has bought the products from Turkey for 100 000E and has done consequent export to
company Y in Romania for 130 000E. Finally, company Y has realized profit as those in the
fraudulent scenario – 270 000E.
4.6.4.3. The Idea Behind the Scheme.
The real companies in the abovementioned chain are only companies A and Y. If company A
had directly bought the sea products from Turkey and had done consequent export to company Y in
Romania, it would have been liable to pay 20 000E VAT from realized importation and receive only
26 000E as a tax credit by the tax authority, which means 34 000E less credit than the fraudulent
scenario. On the other hand, if company Y had made intra-community acquisition for 130 000E itself,
it would have been liable to self-account VAT return in Romania. However, company Y would have
been liable to pay 20% VAT on the realized profit of 270 000E, which is 54 000E without right to
decrease the amount with tax credit from previous purchase. Notwithstanding, all abovementioned
artificial companies make tax obligations to the authorities in Bulgaria and Romania as they are
companies “buffer” and do not pay any VATs.
28
4.6.4.4. Conclusion
The abovementioned example is a typical scheme in Balkan Peninsula with significant losses
for national treasury and budget. It takes time for tax authorities to identify the scheme, which allows
VAT assimilation by company A and a huge tax advantage for company Y in Romania. Usually,
before the scheme to be discovered, companies A and Y have changed the official owners. Those new
owners would be liable to pay the tax obligation accumulated by previous owners.
4.6.5 X-type VAT fraud
The “missing traders” networks has found a relatively easy way to draw down the VAT
account of the missing trader, taking at the same time advantage of the shelter against the joint liability
principle provided by the VAT account. The upgraded version of the missing trader fraud is X-type
VAT fraud, includes s supply “sub-chain”, whose purpose is to draw down the liability of the missing
trader from his VAT account. 85
The initial (primary) goods come from a non-VAT-registered trader A to a VAT –registered
purchaser/supplier B at a VAT-exempt price. The latter acts as a decoy: its task is to ensure the right to
VAT refund to the organizer (O), as (O) pays the tax into B’s VAT account. However, B’s tax liability
85
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29
will not be collectible – when it is established, B will have no balance left on its VAT account. B’s
account is drawn down by purchases from another supplier (C) and the transfer of the VAT on them to
its VAT account. On paper, B receives auxiliary fast moving consumer goods which, it sells to cashbuyers (CB). These are either final consumers or non-VAT-registered traders or VAT-registered
traders whose tax liability is below the official threshold for the particular member state, where the
abovementioned scheme takes place. Nevertheless, the idea is to avoid payment of the VAT charged
on these sales into B’s VAT account. In conclusion then, the VAT payable on the primary supply is
refunded to scheme organizer, having been simultaneously withdrawn from its supplier’s VAT
account. In the meantime, it has also been used to legalize the auxiliary sales. Hence, in its basic
scenario, the X-scheme is a method of VAT evasion, rather than unlawful refund. However, it is
possible to double, at least, its effect if the organizer (O), instead of selling the primary goods on the
domestic market and reporting the sales, exports them fictitiously and sells them domestically for
unregistered cash. Furthermore, it can export them genuinely but at a lower reported value. In addition,
the basic chain could be made much longer and more complicated, with the involvement of a number
of witting or unwitting intermediaries, so as to make it difficult to trace and brake. 86
4.6.5.1 Financial Return on the X-type of VAT Fraud
Description of the X-type fraud with respect to the above diagram: Non-VAT-registered
supplier A delivers goods worth 1,000 to Intermediary/decoy B, the supply is VAT-exempt. Supplier
B adds value of 100 and resells the goods to scheme organizer O at 1, 320 gross, of which 220 goes to
B’s VAT account. Thereby, O is entitled to claim a tax credit of 220. Consequent act is when B draws
down its VAT account by transferring 220 to C’s VAT account in respect of goods (rapidly
marketable) purchased from it at 1,100net. The goods purchased from C are rapidly placed on the cash
market, the VAT on them going straight into the organizer’s “pocket”
4.6.5.2 Unlawful Refund Scenario
There are various types of scenario with respect to abovementioned and described x-type VAT
fraud. In its ordinary scenario the final result is rather tax evasion than tax fraud. However, the link
between tax evasion and tax frauds is also very tiny as the link between tax avoidance and tax evasion.
Unlawful refund scenario could be more distortive than the ordinary scenario. For example: scheme
organizer (O) exports the primary goods on paper to a foreign company in registered in another
member state, charges the zero VAT rate on the export transaction and receives a cash refund of 220 in
respect of its tax credit, while in reality it adds value of (for instance) 500 and sells the goods
domestically for unregistered cash. The net result is that being owed VAT of 540 (a total of 320 on the
two primary supplies and 220 on the auxiliary supply), the treasury gets naught. The same loss effect
86
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30
of 540 is produced if scheme organizer (O) has a genuine foreign buyer to accept the goods at an
invoice price lower than the actual one (which a foreign buyer might have the incentive to, considering
that based on the destination rule it would save VAT on imports. In this case, scheme organizer (O)
avoids the costs and risks of selling the primary goods on the domestic unregistered-cash market.
4.6.6 .The Most Typical VAT Fraud in the Balkan Peninsula
Following the abolition of fiscal border formalities with respect to the previous requirement
for VAT accounting on the border of importing country, VAT on importation of goods from member
states is collecting in the fixed moment by tax legislator. 87The conditions for committing VAT frauds
are optimal when the obligation for VAT accounting on acquisition and delivery in successive
transaction is carried by the same taxable persons, such as deals, taxed with “reverse charge”
mechanism, importation of goods in “deferred accounting” or intra-community acquisition of
goods. 88 In deferred accounting, importer does not pay VAT on the value of imported goods at
customs, when the goods are exempted from customs control, importer is responsible to declare import
VAT in its VAT return period (and deduct the same amount as a VAT for acquisition during the
respective period.
89
The abolition of customs borders between Bulgaria and Romania, after their
acceptance in EU in 2007, allows removing the customs barriers to cross-border frauds involving
Bulgarian and Romanian companies. Very often, in the fraudulent schemes participate companies
from Turkey and Serbia, which sell various goods to fictitious importers from Bulgaria and at the end
of the fraudulent stage the goods are exported to Romanian customers – fictitious or real.
87
Fighting VAT fraud, The Bulgarian experience – working paper by Dr. Konstantin Pashev, June 2006
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Tax Fraud and schemes in EU Member States – Nikolay Terziev, magazine Society and Law, edition 10/2013
Tax Fraud and schemes in EU Member States – Nikolay Terziev, magazine Society and Law, edition 10/2013
89
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The aim behind the scheme is using of unlawful tax advantage by application of zero rate of
VAT based on exportation. The scheme is organized by wholesalers – producers or importers with
high commodity turnover. In the particular example, company A and B are VAT registered traders of
sugar. Usually, they conduct real economic activities and pay respective VATs to Bulgarian tax
authority, which leads to good reputation. Companies A and B maintain sustainable trade relations
with direct suppliers, producers, customers and declared high turnovers. They control artificial
companies for exporting and importing sugar in order to recover unlawful VAT. In the example above,
company A buys sugar form Bulgarian sugar producer, resells the commodity to company C. The
latter acts are intra-community-supply between company C and company D registered in
GreeceAfterwards, company D makes consequent supply to company Y registered in Bulgaria. The
commodities go through another company X (buffer) before to reach the final customer – company B,
which in turn, resells the received commodities to private consumers. Company C (agent) is
unofficially controlled by company A. It is a wholesales trader with agent /intermediary/
characteristics and declare fictitious intra – community supplies to Greek face company D, which
leads to tax recovering of VAT by the tax authority in Bulgaria. However, the benefits are consumed
by the controlling company A and B. Companies D and E are fake companies registered in Greece on
the names of Bulgarian half-literate persons with low standard of living. These companies are
controlled by the organizers (company A and B), they are not detected by the tax authorities of Greece
and have characteristics of “missing trader”. When a particular fraud involves two or more foreign
32
suppliers in the chain, some difficulties could arise for the revenue authorities to gather evidence with
respect to commodity movements and supply appearance (legitimate or fake). In this occasion,
assistance from foreign authoritiesshould be sought through administrative cooperation. Once,
company D has made intra-community acquisition, it has two alternative option for reselling the
commodities: the first option is reselling to Bulgarian fake company (company Y in the scheme
above) or through another foreign artificial company (for example company E in the scheme above).
Company Y always makes intra-community acquisition in both scenarios. It is an artificial company
controlled by companies A and B. However, in order to achieve higher levels of latency, the
organizers involve a company “buffer” – X, which makes the scheme much more difficult for trucking
by the authorities regarding the commodity’s origin. Particular difficulties for the tax authorities to
justify their claims and statements with respect to any illegal actions made by taxpayers and
participation in tax evasion would arise when the physical movement of commodities to another
member state is truly organized in order to give the impression that they are intended to be consumed
in that member state as a final destination. At the end stage of the scheme, company X supplies the
commodities to company B, which in turn, resells them to private consumers. There is another
scenario in the scheme, when the sugar producer itself makes fictitious exports to company D in
Greece in order to receive a VAT refund, however, the producer sells the commodities unofficially to
company B, which officially shows in its accounting sheets and trade documents that has bought the
commodities from company X (such as the first scenario)
4.6.6.1 Financial and Tax Advantages from the Scheme
VAT registered producer sells sugarto company A (the wholesaler of sugar) and issues an
invoice with tax base 100 000E and 20 000E VAT. However, the deal between company A and B is
hidden to tax authorities, consequently company A delivers the commodities to company B without
issuing any invoices. If, negotiated price of sugar commodities between both companies A and B is
(for example) 120 000E, company B pays the amount without any tax consequences, which means that
company A generates a clear profit of 20 000E. For more tax and financial advantages for both
companies A and B, the scheme continues with fictitious deal between company A and C
(intermediary). Company A issues an invoice to intermediary C with tax base of 130 000E and 26
000E VAT. Consequently, officially company A is liable to pay only 6 000E VAT to the tax
authorities (the difference between purchase and sales). However, company C is alegitimate entity
controlled by company A. It makes fictitious export (intra-community supply) to Greek artificial
company D registered in Greece. Company C issues an invoice with tax base of 160 000E without
VAT amount, as the commodities leave Bulgaria with zero rate VAT. However, company C receives
32 000E VAT recovering by the tax authority in Bulgaria. As the company C actually does not have
any expenditures (there is no real purchase from company A and sale to company D in Greece), it
gains 32 000E clear profit from its fraudulent activities, which automatically goes to company A (as
33
company A is organizer of the scheme). Company A pays its tax obligation (6 000E) to the tax
authority and calculates clear profit of 26 000E “earned” from the fraudulent activities. In Greece,
company D makes fictitious intra-community acquisition, hence it is liable to self-account 32 000E
VAT and deduct the amount in the same VAT return declaration if the commodities will be realized in
the Greek market. Company D fictitiously resells the Bulgarian sugar production to another artificial
company registered in Greece - company E and issues an invoice with tax base of 180 000E and 36
000E VAT. Hence, company D is liable to pay 4 000E VAT to the Greek authorities, as it can deduct
the VAT amount of 32 000E, self-accounted after the fictitious acquisition. Company E makes
consequent export to company Y in Bulgaria, which is “missing trader” and issue an invoice with tax
base of 200 000E without VAT. The Greek tax authority recovers 40 000E VAT. Company Y selfaccounts in its VAT return the amount of 40 000VAT and makes local supply to company X (buffer)
with aim to increase the scheme’s latency. Finally, company X issues an invoice to company B (the
other organizer of the scheme) with tax base (for instance) 220 000E including VAT. Company B
realizes various sales to private consumers for 225 000E, consequently is liable to pay only 1 000E
VAT, which means that company B saves around 25 000E (from VAT point of view) – as the goods
are unofficially bought for 120 000E from company A. The scheme illustrates, that the link between
tax evasion and fraud is a matter of an additional discussion. It depends on what will be disclosed by
authorities and institutions and how the fraudulent activities would be interpreted. Furthermore,
ignoring the technicalities involved in the various organized VAT fraud schemes, they involve the use
of the right of credit by a zero-rate trader before his accomplice up the chain has paid the
corresponding tax liability.
90
If the credit system causes such problems in compliance and
enforcement, then the first policy question to be considered is whether or not the modern tax and trade
system can do without it? 91Suspending of the credit mechanism only for exports could be taken as an
argument with respect to above issue. Notwithstanding, this is the rationale behind the proposal to the
Bulgarian Parliament to exempt the inputs to exporters from VAT, so that they would not able to claim
credit on them. 92
4.6.7. Selling of invoices to real business entities.
In this scheme, company A is a legitimate entity with a long trade story. However, the profit
starts to decrease and this leads to ownership transfer from previous owners to self-literate person who
is placed by organized group of committing frauds. The negotiation is between the initial owners and
the organized group. Usually, before transferring the business assets, transferred entity has already
made significant tax obligation. The new trade policy of company A is selling of invoices to various
90
Fighting VAT fraud, The Bulgarian experience – working paper by Dr. Konstantin Pashev, June 2006
On the pros and cons of the alternative VAT designs see Ebrill, L. and M. Keen, J-P. Bodin and V. Summers
The Modern VAT,IMF, 2001
92
James, Jorge Martinez-Vazquez and Sally Wallace (Editors), Taxing the Hard to Tax: Lessons from Theory
and Practice Elsevier, 2004
91
34
legal entities, which want to decrease their tax liability, including various fake invoices. Company A
makes a lot of fictitious purchases from artificial companies 1, 2 and 3. The last declare purchases
from companies X and Y – also fake companies, which on turn make fictitious deals with artificial
companies 4, 5, 6, 7 and 8. Company A declares sales to different entities for 1 000 000E and
purchases for 700 000E. Consequently it makes an additional tax obligation with amount of 60 000E
(1 000 000 – 700 000 x 20%VAT). Those business entities are liable to use fraudulent tax credit with
overall amount of 200 000E – which illustrates the revenue losses for the national government. All
other artificial companies make different tax obligation to the national tax authority. Their owners are
also self-literate persons with low standard of living, or homeless people. This leads to very difficult
tax verification and investigation. In this occasion, those people are usually declared for nationwide
search by national police bodies.
.
4.7 Tax evasion or tax fraud?
4.7.1 Restaurant management through artificial companies.
Case law …/2013 of Regional Court of Justice – Varna /Bulgaria/. The case illustrates very
typical scheme in Bulgaria. A restaurant with significant turnover is officially managed by artificial
companies between 2009 and 2012.The process starts in the beginning of every calendar year and
finishes at the end of it, when the restaurant is being transferred to another artificial entity. In the
particular example, artificial company A is newly created in 2009 with aim to accumulate significant
35
VAT obligation to the tax authority based on the restaurant’s profit for 12 months. The restaurant
issues cash receipts to its clients on the name of the artificial entity. Company A purchased goods with
overall value 460 000E for the period between 1st of January 2009 – 31st December 2010 93 and
accumulated an annual turnover of 1 400 000E. After all expenditure deductions, company A was
liable to pay 160 000E VAT to the tax authority in 2009. Company A has been controlled by the
restaurant owners – a family who owned the land and the building. The family signed rent contract
with the official owner of the respective artificial entity for the period of one year. As soon as the
contract ends,a new rent contract for one year has been signed with the owner of the new artificial
company (in the current case – company B). The abovementioned fraudulent process was repeated
with company B during the whole year (2010). The scheme continues with company C in 2011 and
company D in 2012. The process is similar as that one in 2009 and 2010. The restaurant having been
managed by four different artificial companies accumulated tax obligation with overall amount of 680
000E VAT for the period of four years, which has been due by all companies. However, their official
owners have been homeless people with very low level of literacy. The court ruled the lack of
subjective element with respect to those official owners and lack of any evidence against the family
“X” The case has been suspended against unknown perpetrator for tax evasion. 94
93
94
Case law …./2013 of Regional Court of Justice – Varna,
Information based on my experience as a police investigator
36
4.7.2. The postponed payment facilitates tax evasion.
Another tax scheme is chain transactions of fictitious goods with arrangement for postponed
payment between all companies in the chain. Initially the chain starts with fictitious deals of metal
elements between fake company A registered on the name of homeless person and unknown private
individuals. All deals are unofficial and there is no invoices issued. Company A hires a warehouse in
which declares storage of those metal elements. In latter stage, company A sells all these metal
elements to company B (a legitimate company dealing with restaurants and night clubs) for 600 000E
and makes a tax obligation of 120 000E to the Bulgarian tax authority. The arrangements between
both companies are postponed payment, which will be realized as soon as company B resells the
commodities to a foreign company. An additional arrangement is all metal elements purchased by
company B to remain for storing in the hired warehouse by company A until their exportation to a
foreign customer. Finally, company B declares export to Romanian artificial company Y for 850
000E. Company B includes the invoice issued to the Romanian company in its accounting books and
declares VAT return to the tax authorities. Consequently, the tax authority in Bulgaria recovers VAT
return of 170 000E to company B. However, the abovementioned arrangement for postponed payment
is valid for company B and company Y as well. Hence, there is no real payment with respect to the
export deal. Actually, company B manages various restaurants and night clubs in Bulgaria. The aim
37
behind this scheme is decreasing of required tax liability. On the other hand, company Y also includes
the issued invoice by company B in its accounting books of purchases. Thereafter, the tax authorities
in Bulgaria make a tax verification with respect to the recovered VAT return. In collaboration with the
Romanian tax authority, it becomes explicit that there is no payments with respect to all chain
transactions. There are only tax documents issued with the fraudulent aim of unlawful assimilation of
tax return. During the tax verification in Bulgaria, the owner of company B transfers company’s assets
(accept the trade objects) to a self-literate person. Latter on, the ex-owner of company B establishes a
new company D on the name of another self-literate person with low standard of living. The last,
being an owner of company D buys all trade objects from company B for (let’s say 1 000 000E). This
expendituresare included in the accounting books of company D. In turn, company B makes an
additional tax obligation based on realized sales of the trade objects, which increases the previous tax
obligation. Company D continues to manage the trade objects. The scheme is a real case in Bulgaria
which has been under pre-trial proceeding, which has been suspended against unknown perpetrator for
tax evasion. 95
4.8. Conclusion
Some businesses are more prone to the abuse of tax credit than others and the tax
administration may treat them differently. The missing trader scam is usually associated with highvalue goods such as sugar commodities, farming goods or scrap metals, which can generate sizeable
credit claims. It could be argued that risk assessment audit targeting and administrative control needs
to be differentiated according to sector taxpayer and product characteristics, to maximize the
effectiveness of prevention and deterrence. 96 On the other hand, there is no doubt that the VAT is
susceptible to evasion and fraud, running all the way from the occasional concealed sale to
sophisticated and large scale attacks by organize crime. 97 Nor is there any doubt that, although many
of the frauds to which the VAT is vulnerable also arise under (for example) the structure of the tax –
notably the payment of refunds, particularly on exports – does create distinctive control problems.
Most often the missing/insolvent trader is implemented through repeated rounds of cross border
transaction known as carousel fraud. This on the one hand, makes tracking and countering it more
difficult and slow, while on the other, it multiples the cash return on the missing-trader fraud. The
spectacular and highly organized nature of many carousel and related frauds is cause for particular
concern, beyond the associated revenue loss itself, in the risk that it carries for the wider respect in
which the tax system is held.
95
Information is based on my previous experience as a police investigator.
Fighting VAT fraud, The Bulgarian experience – working paper by Dr. Konstantin Pashev, June 2006
97
VAT fraud and evasion: what do we know, and what can be done – IMF working paper by Michael Keen and
Stephen Smith
96
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5. Conclusion
In conclusion, the aim of this paper was to describe the difference between tax avoidance and tax
evasion as the lawful and unlawful way of reducing a tax liability. Thedifference between tax evasion
and tax fraud was taken into account with particular frauds schemes committed in the Balkan
Peninsula. It is my opinion that careful distinction between avoidance, evasion and fraud should be
made in order to distinguish every method or scheme as legal or illegal. When a company crosses the
line of lawful ways to avoid paying taxes with more aggressive actions is indication for tax evasion,
when the profit is decreased illegally or significant part ofit has “mysteriously” disappeared from the
balance sheet. Tax avoidance is a desire to minimize the payment of taxes by legal means or with other
words the legal use of the tax system to reduce the tax liability. It was described that tax avoidance
also involves the banding of the rules of the particular tax system in order to gain a tax advantage that
the parliament never intended. Sometimes tax avoidance implicates artificial transaction, which are
more typical for committing tax frauds. Nevertheless, tax avoidance is when businesses operate in the
letter of law, which is the most significant distinction in comparison with tax evasion. The last term
occurs when a business deliberately does not account for the tax owed. Tax evasion is the crime of not
paying taxes on realized profits by a business entity. On the other hand, tax evasion could be done
intentionally or unintentionally by making mistakes or by unlawfully escaping payment, which usually
is a subject to a prison term or fine. The person who is guilty of committing such criminal offences is
referred to as a tax evader. Crossing the border between lawful and unlawful ways to avoid paying
taxes leads to tax evasion. Tax evasion could be achieved by making mistakes, which is definitely not
a crime, tax fraud intentionally acts as refusing to pay taxes or unlawful assimilation of tax returns,
which is usually based on fake exportations to another member state. It could be argued that when a
business is trying to hide its profits it is referred to tax evasion, however, when a business is trying not
only to hide the generated profit but rather to receive an unlawful tax return, which usually is based on
fictitious export refers to tax fraud. Consequently, the business efforts to reduce the tax liability or to
avoid paying taxes should be made by operating in the letter of law or lawful binding the rules, which
is allowed by the tax legislator. In turn, binding the rules means that the mechanism of avoidance is
based on loopholes, which have been found by advisors and consultants. Those loopholes lead to legal
reducing of tax obligation, which is tax avoidance. However, if the loopholes are combined with
illegal methods of decreasing the tax liability is tax evasion than. Hence, every single action taken by
the authorized person – auditor, attorney, advisor or consultant should be made very precisely. Every
step for declining particular tax liability should be launched reasonably and notwithstanding legalities
in order to avoid undesired consequences in the face of tax authorities and government. One should
bear in mind that the difference between tax avoidance and tax evasion is not only miniscule but
sometimes a seemingly lawful act could be interpreted as illegal by the competent authority.
Furthermore, no perfect system seems to exist that can work the miracle of distinguishing easily
39
between fraudsters and law-abiding taxpayers and delivering the deserved punishment on the guilty
while shielding the others from the tax authority’s errors of judgment. A trade-off is necessary
between the interest of business and those of the administration, based on a clear understanding of its
net benefit. This implies, for tax officers, that they should learn to live with the fact that fraudsters are
after all the exception and not the rule, and also, that they should be ready to accept responsibility and
liability for their errors and the damage caused to compliant taxpayers, nevertheless, to make clear
individual distinction between every single case for accurate determination of tax avoidance and tax
evasion, or even fraud. 98On the other hand, businesses should learn to live with the principle of joint
liability and such other restrictive measures, especially if it operates in a high-risk sector, as a
necessary cost to be incurred if VAT fraud is to be reduced and with it, unfair competition and the
need for higher tax rates. Finally, tax avoidance and tax evasion are meant to ultimately reduce tax
liability. The main difference between both related terms is that the former is justified in the eyes of
the law as it does not make any offense or break any law. It is biased as the honest taxpayers can also
make some arrangement for postponing unnecessary taxes. If one talks about the latter, it is
completely unjustified because it is a fraudulent activity, involving an act that is forbidden by law and
hence it is punishable. 99
98
VAT fraud and evasion: what do we know, and what can be done – IMF working paper by Michael Keen and
Stephen Smith
99
Difference between tax avoidance and tax evasion – article by Sutbhi S. May 16, 2015
40
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My one experience as a police investigator in the Economic Department of Varna / Bulgaria /
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