The European Commission announced an overhaul of the EU’s VAT (sales tax) system on Tuesday in its latest attempt to prevent its much-vaunted carbon trading system being riddled by multimillion-euro fraud.

Criminals who for years had been ripping off VAT from finance ministries around the EU on the trade of items such as mobile phones and computer chips have recently moved in on Europe’s €90bn carbon market.

Last month the UK Revenue & Customs raided 27 businesses and private addresses across London in relation to a suspected £38m VAT fraud on carbon credits. It has since released nine suspects on bail but the investigation is continuing.

With just two months to go before the Copenhagen climate summit in December, the EU is desperate to get its house in order as it tries to get its form of “cap-and-trade” carbon trading scheme adopted around the world as a key weapon against carbon emissions.

Officials know that a carbon market leaking millions to VAT “carousel” fraudsters would be difficult to sell on the international stage so it has moved quickly in response to a surge in VAT fraud on carbon this summer.

Brussels said it would harmonise policy between EU states and introduce a so-called “reverse charge” mechanism, which would remove the need for VAT to change hands between carbon traders every time carbon credits are sold.

This was the method adopted by the Dutch government in July as carbon traders noticed a surge in trading volumes that could only be attributed to fraud. The French government simply removed VAT from carbon markets, while the British made carbon trading zero-rated for VAT purposes. The three countries are home to the bloc’s main carbon exchanges: Climex in Amsterdam, BlueNext in Paris and London’s Climate Spot Exchange and European Climate Exchange.

Laszlo Kovacs, the European commissioner for taxation and customs, said: “VAT carousel fraud is against member states’ finances and they should have the means to combat it efficiently. However, actions taken against this fraud should be taken in a consistent manner across the EU and clear evaluation criteria should be established.

“Very recently, several member states have been confronted with carousel fraud related to greenhouse-gas emission allowances ... the very high mobility of these allowances and the very high amounts at stake are an important element.”

A U.K. Treasury spokesman said: “The UK government took decisive action in July to protect taxpayer revenue from the threat of VAT fraud on carbon credits.

“We support the commission in seeking an EU-wide solution and will consider any proposal carefully.”

In its simplest form, the fraud occurs when a trader of credits in, say, Britain, buys some from another country free of VAT, then sells them on within Britain, charging the VAT to the buyer. The seller then disappears without handing the VAT over to the taxman. This is known as “missing trader” fraud. Some criminals re-export the credits, reclaiming VAT as they do so, then re-import them again. They can do this repeatedly, reclaiming VAT many times, hence the term “carousel” fraud.

Britain lost billions of pounds to carousel fraud, mainly on mobile phones, in 2006 and 2007 before the government changed the mobile trade to “reverse charge” VAT, meaning the tax was only levied on the final buyer and removed from the supply chain.

The European Union’s carbon market is now worth about €90bn a year. It is a combination of futures and spot trading and it is the largely unregulated spot market that has been targeted this summer by the fraudsters.

The European police agency, Europol, has said it is convinced many other carbon credit VAT frauds have been committed across Europe but the total losses to national governments are largely unknown, although probably run in to the hundreds of millions of euros.

Sophisticated fraudsters

“This represents a considerable degree of sophistication on the part of the fraudsters,” said Andrew Roycroft, a tax lawyer with Norton Rose.

He noted that the commission had also empowered member states to bring in a reverse charge on other items where fraud is suspected, including trade in perfume and in precious metals such as platinum - widely used in jewellery and catalytic converters in cars.

“There is clearly a problem in more than one member state and not just in the markets for mobile phones and carbon credits,” he said.

Richard Ainsworth, professor of VAT policy at Boston University, in the USA, applauded the commission’s move as a short-term fix. But longer term, he said, countries could fix their VAT systems and make them fraud-proof by introducing a system of certified tax compliance software that firms would have to use to prove their legitimacy. — © Guardian Newspapers Limited, 2009

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