HM Revenue and Customs’ (HMRC) battle against missing trader VAT fraud has probably not been likened to a Punch and Judy show before now.

The IT industry – principally in this case CPU and mobile phone traders – are the downtrodden Judy character, generally trying to get on with the everyday chore of looking after her baby (running their businesses) and being hindered by Mr Punch (HMRC) every step of the way for no apparent reason apart from the fact that he can because he is bigger and stronger.

This is of course not to say that there are not some traders both in the UK and the wider European Union (EU) who have been taking advantage of the loopholes in the VAT system to prosper from missing trader (MTIC) or carousel fraud, but there are many who are just business people trying to make an honest living from selling chips, components and mobile phones.

HMRC has been frantically throwing money and resources at the growing problem of VAT missing trader fraud for a number of years. It has also battled stoically with its counterparts on the EU European Economic and Finance Committee (Ecofin) for the implementation of a blanket Reverse Charge strategy – which levies VAT onto the customer rather than the seller of goods. After much debate, several delays and modifying the strategy to cover just the CPU and mobile phone market for orders over £5,000 – Reverse Charge came into force on 1 June in the UK.

However, running parallel with Reverse Charge is the deeply unpopular Extended Verification strategy. Extended Verification came into place while the government was still negotiating with the EU over Reverse Charge. Extended Verification witholds VAT repayments until HMRC has completed checks on the supply chain. The premise of which appears to be that every trader in the mobile phone and chip sector must be treated as guilty until proven innocent with the hope that some VAT fraudsters would be hit in the pocket.

In the words of Paymaster General Dawn Primarolo, during a BBC interview earlier this year: “A delay for the innocent is better than a payment to the guilty.”

Hundreds of UK traders as a result are being forced to at best survive on the breadline and at worse go bust, because of Extended Verification, with some waiting more than 18-months for their VAT repayments.

However, despite this HMRC continues to defend its strategy to the hilt. In a statement released to CRN on numerous occasions, it said: “HMRC’s strategy to counter MTIC fraud has had a significant impact on the levels of trade associated with fraud. However, our Extended Verification work has little, if any, impact upon those whose trade is unconnected with MTIC fraud. Our activity is closely targeted on the traders and claims that bear the distinct indicators of involvement in MTIC fraud. These are a tiny fraction of one per cent of the 1.9 million VAT-registered traders and indeed a tiny proportion of those that regularly submit repayment claims.”

Earlier this year CRN launched a campaign to highlight the plight of innocent traders whose businesses have been decimated by Extended Verification. The firms that came forward have been owed sums ranging from £110,000 to several million pounds. A few have taken their cases to Judicial Review and are now awaiting Industrial Tribunal hearings.

Some traders have even involved their local MPs in a bid to get their cases heard and one director of a firm that has been forced to suspend trading due to Extended Verification, launched an online petition against the strategy earlier this year.

Monty Jivraj, managing director at mobile phone trader Olympia Technology Ltd, which spearheaded the petition, told CRN: “We have had more than 400 traders sign the petition now, but I don’t see how the situation is going to change. Someone has to draw the line that this is going to stop and maybe there should be some kind of time limit imposed on Extended Verification. There is either fraud or there is not, but it doesn’t give HMRC the right to affect livelihoods the way it is doing. The UK is one of the leading players in the tech world as far as Europe is concerned, but the industry is being completely disrupted.”

HMRC also stated that it pays claims back ‘immediately’ once it is satisfied that the claim is valid.

However, Fred Howarth, director of the Federation of Technological Industries, a trade body that represents mobile phone and chip traders and that has launched its own legal action against HMRC, disputed this claim.

“To date, all traders subjected to Extended Verification have either had negative decisions or no decision,” he said. “There have been no part payments of transactions that have been cleared. HMRC is starting to make repayments for non-trading claims such as overheads, freight forwarder bills and such, however, even these are being released under duress.”

Last month, the House of Lords of Economic and Financial Affairs and International Trade sub committee, released a report that claimed VAT fraud is ‘out of control’ and stated that Extended Verification is an ‘inefficient and unsustainable’ use of resources and imposes a ‘significant burden’ on smaller firms. It also branded Reverse Charge as a ‘temporary solution’ that is likely to cause the fraud to ‘mutate into other sectors’.

As an alternative, the report suggested that “a wide-ranging change to the VAT system is required and the Government should start discussions with the European Commission (EC) and other member states on the form this should take”.

Dennis Knowles, partner at accountancy firm Deloitte agreed, but said the entire European VAT system is still in a ‘transitional phase’.

“I can understand why HMRC is carrying out Extended Verification, but it must be careful that it does not impact on legitimate business,” he said.

Knowles added that there are a number of ideas being mooted about changes to the VAT system and it is seen as an issue that is growing in importance across the wider EU.

“HMRC is gradually getting to grips with the problem in the UK mobile phone and chip industry, but there is recognition across the EU that something needs to be done about the wider VAT issue,” he said.

“The mood has changed, but we need all 27 member states to agree. It has been the more western member states such as the UK, France, Germany, Spain and Portugal suffering from MTIC fraud, but they don’t want it to migrate to other countries. Now the mood is changing and all member states want to give more focus to making changes to general legislation.

“We are in a transition phase with VAT and it has gone on a lot longer than anticipated. At the end of the day it needs to be modernised – not only with goods, but also with services and this requires a root-and-branch view on the system as a whole.”

There is no doubt that HMRC believes its tough stance on VAT fraud is working, but it cannot ignore the fact that its strategy is having an adverse effect on the whole industry and that many innocent traders have been brought to their knees as a result because they simply cannot fight an organisation as large and powerful as HMRC.

The general mood seems to be swinging towards a change in the general VAT system across the EU. This is not a short-term goal, it is going to take time. But providing all the EC member states can play together nicely and come to some agreement over a unified VAT strategy, some of those firms affected might be able to start rebuilding their shattered businesses once more.

VAT fraud is out of control, House of Lords claims