Do you know where your goods came from?

The measure – one of a range to combat VAT fraud – created a storm in parliament, but has so far provoked hardly a ripple of concern among the business community. After all, 90% of companies aren’t affected.

Economic secretary John Healey went out of his way to assure parliament that no business would be hit with a claim for missing trader VAT without receiving a written warning.

So everything’s all right then? Not quite. For a start, there are whispers that if the measure – designed to combat ‘carousel’ or ‘missing trader’ VAT fraud – works well on telephones and computer parts, it could be extended to other industries, such as the drinks industry and the rag trade.

In any event, Customs’ move raises a broader question – the need to be more circumspect in the choice of supply chain partners. It’s not difficult to find examples of reputable companies embarrassed by the shenanigans of some partners. In some cases, it’s because the lead company doesn’t know what’s going on; in others it’s because the company turned a blind eye in return for a cost advantage.

Some companies were recently embarrassed by Denby Poultry Products, a company that bought contaminated chickens for £25 a ton, then sold it on as prime poultry for £1,792 a ton to food processing firms that produced fillets and ready meals for major supermarket chains. One company had to institute an expensive product recall on meat paste products when it discovered the truth.

These kinds of issues are tied up in the question of corporate reputation, so FDs might be forgiven for wondering what they’ve got to do with them.

But brand investment is a top-line cost for many companies and a damaged reputation acts as a negative investment in the brand.

Nor is the problem limited to the private sector. Earlier this year, Home Office ministers had red faces when it was revealed that plywood, used for hoardings and to hold wet concrete in place on the site of their new headquarters in London, came from illegal logging of Indonesian rainforests.

Greenpeace protesters occupied the site and declared it ‘an ancient forest crime scene’.

So what is to be done? On the broader question, Lauren Darby, a research associate at the ESCR Centre for Business Relationships, Accountability, Sustainability & Society at Cardiff University, says: ‘Companies (must) pay attention to the operations and activities of their suppliers.’

But this isn’t as straightforward as it may seem. Darby points out that potential hot spots in the supply chain are likely to vary, depending on the business. For example, Nike has been criticised for using ‘sweat shop’ labour, while some oil firms are hounded by environmental groups.

A list of danger areas includes supply chain partners’ policies on health and safety, equal opportunities and environmental management.

‘You need to think through how you’d handle an issue if you found something that wasn’t acceptable,’ says Darby. ‘You’d have to act on it because there could be major implications to your company’s reputation.’

There is nothing novel about insisting suppliers adopt certain standards. This is already done in manufacturing, with the quality ISO9000 standard.

For many companies, it’s time to extend the principle to other areas, which brings us back to the question of joint and several VAT liability.

It’s not hard to see Customs’ point of view. It says that carousel fraud is running at £2.75bn a year. In these frauds, it has evidence of boxes of goods circulating as much as 35 times. By the time they’ve circulated six times, they’ve generated their own value in money cheated from the public purse. More than 80 carousel frauds are awaiting trial.

Even so, Tim Buss, director of VAT services as accountants PKF, says the notion of joint and several liability introduces a worrying principle into taxation. ‘There are some pretty hefty frauds, and a number of innocent people are being affected. In extreme cases, it could stop trade in a number of areas.’ He knows of some retailers not taking in new stock until the VAT liability question is clarified.

Apart from the joint and several liability, Customs now has the power to demand security in the form of a guarantee or upfront payment from businesses in supply chains that consistently involve missing traders.

And affected companies may not be able to claim back input tax on invalid invoices unless they can also satisfy Customs that they took ‘reasonable steps’ to ensure their supplier was bona fide.

In April, Customs published a consultation document that set out a draft of reasonable steps that cover three main areas. First, ensuring the ‘legitimacy of customers or suppliers’ by doing things such as looking at their history, whether normal commercial arrangements are in place and whether the goods in the transaction are adequately insured.

Second, whether the transaction looks viable from a normal commercial perspective. This means asking questions about whether there is a market for the goods whether it’s reasonable for the price to increase within the supply chain and whether normal practices have been used to negotiate prices.

Third, that the goods received are as described. That means if they exist, have been previously supplied or are in good condition.

On the face of it, the reasonable steps don’t appear unreasonable, but Buss is worried about how they will be applied. ‘I fear Customs may take the view that if you haven’t answered all the questions, you may be liable for the VAT,’ he says.

FDs should alert their boardroom to the financial consequences of being too slapdash when choosing supply chain partners. The chain reaction of wrong choices could blow a nasty hole in the bottom line.

  • Peter Bartram is a freelance journalist. This is an edited version of an article that first appeared in Financial Director in September 2003.

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