More VAT refunds delayed as HMRC steps up fraud investigations

The figures show a 44% increase in the past year in the number of VAT refund claims subject to HMRC's Extended Verification Process (EVP), which is the first rise in the number of referrals in the past five years.

Tax expert Jason Collins of Pinsent Masons said that the increased scrutiny was due to the rise in UK VAT to 20% in January 2011, which has made it more profitable for fraudsters to exploit European VAT law loopholes in the UK than in other major European countries.

"HMRC has responded to the threat of increased VAT fraud by withholding more refunds for longer periods to check whether the claim is fraudulent," he said. "However, the danger is that many legitimate companies will be caught up in this crackdown. VAT refunds can be quite sizeable, so delays in receiving them can hit a business' bottom line."

"A combination of rule changes and a low UK VAT rate meant VAT fraud in the UK was on the wane until recently. The VAT rise looks like it could have reversed this trend," he said.

According to the figures, the number of VAT refund claims selected for the EVP had steadily fallen since 2008/09. However, 584 claims were referred in the year ending 31 March 2012, up from 405 claims the year before. The EVP is used where HMRC suspects that a refund claim is related to fraud. VAT-registered companies are entitled to recover the VAT that they have paid on goods they have purchased themselves, to the extent that they are making taxable supplies for VAT purposes.

VAT fraud costs the UK up to £1 billion annually, according to HMRC estimates. Typical frauds include missing trader intra-community (MTIC) and 'carousel' frauds, which take advantage of the VAT exemption where goods are imported or exported within the EU.

The frauds rely on lengthy circular supply chains controlled by fraudsters, particularly those where small, high value items such as electronic goods or alcohol are traded. The fraudsters will reclaim the VAT on the purchase of the items from the relevant national tax authority; however, that tax authority will not then receive VAT from other parts of the supply chain when the items are sold on.

The rules allow tax authorities to deny a VAT refund claim to other companies in the supply chain that "knew, or should have known" that the transaction was fraudulent. This means that authorities do not have to go after fraudsters directly.

Tax expert Jason Collins said that this process was a "source of frustration" for legitimate businesses, as they could be faced with bills running into the tens of millions of pounds if HMRC concluded that they could have discovered that they were trading in the same supply chain as a fraudster. He said that HMRC had other tools to combat fraud, such as by having purchasers rather than sellers account for the VAT on goods that tended to be subject to fraud. Certain supplies of mobile phones and computer chips are currently subject to this kind of 'reverse charge mechanism', as are transactions in carbon emissions allowances.

"HMRC will hold onto VAT refunds if there is any hint that a business has been 'set up' or targeted by organised fraudsters and should have spotted the tell-tale signs, or turned a 'blind eye', so it is very important that businesses make sure they give investigators no reason for suspicion," he said. "HMRC might take action if there is VAT fraud being carried out somewhere in a company's supply chain, or if HMRC suspects a company's products are being used to carry out frauds."

"It's very important that companies know their supply chains like the back of their hand and that they're on the look-out for any suspicious activity. The fraudsters will usually reduce the price of the goods to make them more easily sellable; using the VAT they never intend to give to HMRC as their margin. The reduced price creates a false market in the goods and the fraud can quickly go viral," he said.