INTERVIEW: The taxman cometh - Kovacs battles against VAT fraud

By bne IntelliNews February 20, 2008

Tamás Gordon in Brussels -

Tax may not be something that everyone understands; unfortunately, it's something that everyone has to pay. So while László Kovács' job as the European Commission's taxman isn't the most glamorous of appointments within the executive, it's nonetheless one of the most crucial.

At the top of Kovács' list of tax matters to take care of is VAT fraud. The Commission estimates that yearly €200bn-250bn is lost to fraud, mostly through the so-called "VAT carousels," which in its simplest form involves a fraudster obtaining a VAT registration to acquire goods tax-free from a trader in another EU country, who then resells the goods at a higher, VAT-inclusive price, but disappears without paying the tax to the state. The goods are then re-exported while claiming back the VAT, enabling the goods to then be re-imported and sent round the carousel again.

The problem, explains Kovács, is that because the tracking process is so slow for VAT on goods, it's very difficult to identify if there is fraud involved. The present EU directive allows tax authorities three months in which to share the necessary information. However, if a company is only established for the purpose of committing fraud, then after three months the company in question will simply cease to exist.

In 2007, Kovács presented a plan with alternative options, the first being a simple and very traditional one: better cooperation among tax authorities and a faster exchange of information aimed at tightening control of the system. This doesn't promise too much for stamping out the practice, but it will provoke the least opposition from the various member states. "My intention is to present to the commission - still in February - a draft directive which would reduce the three-month period to one month," says Kovács, adding that this proposal can then go to the Economic and Financial Affairs Council (Ecofin), which is composed of the economic and finance ministers of the EU-27, in March.

A second, more contentious option would be the introduction of a much more complex system (known as the reverse-charge system), currently under preparation by the administration, whereby VAT would only be paid by the customer rather than by the supplier. "According to some member states and experts, this system is the only one which can work. However, certain members see it differently: the system opens other backdoors for fraud," says Kovács. "Last year, there was a discussion about it in Ecofin, and to Germany's surprise, it won backing only from Austria and Malta. In any event, the Commission is going to present in April a detailed impact study. There will also be a further study, which looks into the consequences deriving from a pilot project, in which Austria would try out the reverse-charge system."

Kovács says there's even a third option that could prevent carousel fraud - if VAT is paid in the context of intra-community trade. Since this option - which has not yet been discussed by Ecofin - is a very complex one, it will also require an impact study. The results of this study are due out in April.

Practical steps

Kovács is known in Brussels for his practical approach to finding solution to problems. This was certainly the case when he dealt with the politically sensitive issue of reduced VAT rates, where he managed to convince Ecofin to accept his proposals to reforming this issue. "In my opinion the system is maybe legally all right, but I question its fairness. Look at the agreement of 1992, when 12 member states agreed on a list of goods to which a reduced or even a zero rate could be applied - this system was closed to the countries which joined the EU later."

In 1998, another list was drawn up of labour-intensive services on which eight member states could apply lower VAT rates on an experimental basis. Certain countries - especially Germany - want to halt this. And there is also the issue of new member states receiving certain dispensations - or "derogations" in Euro-speak - to apply reduced rates, which are meant to be gradually phased out.

Kovács managed to reach a compromise. He proposed maintaining the status quo plus postponing all the expiration deadlines until the ministers can agree on reforming the whole system. He argues there's no sense changing only a part of the system, and then later introducing new rates again. Kovács is working on a complete reform package that should come into effect from January 2011.

In the meantime, the EC commissioned a study that, surprisingly, reached the conclusion that economically the most rational solution would be for no reduced VAT rates at all but a single uniform VAT rate per member state. However, the study recognises that specific economic benefits can be obtained by applying reduced rates to carefully targeted sectors. Therefore, Kovács' package is going to include reduced VAT for certain goods and services, such as environmentally-friendly products, books, perhaps baby wipes, and as a particular Swedish wish, to bring into the scheme audio-books. Finally, member states can provide incentives for labour-intensive industries and to some local services, especially the restaurant business (a long-time French request). "There are some arguments to introduce VAT reduced rates in sectors employing many low-skilled workers in order to permanently create jobs for low-skilled workers. However, overall net employment gains seem to be minor," the survey concluded.

Thus, Kovács' reform package would bring to an end the privileges of old member states and stop discriminating against the newer ones.

Saving abroad

The European Commission is also keen to reach agreement on savings tax with three Asian countries: Singapore, Macao and Hong Kong have so far refused to share EU residents' bank data with EU member states. And Hong Kong repeated its objection to Kovács' face.

As part of a review of the 2005 agreement that saw the EU, plus five additional European countries and 10 former colonies impose tax on savings, Brussels wants to extend this deal to include these three "tax havens." To help push the plan forward, Kovács personally travelled to Hong Kong in early February. "The essence of the savings taxation directive is that a country either taxes a non-residential citizen's savings or provides information about the sum to the citizen's tax authority. The problem with Hong Kong is that it does not impose any taxes on savings and thus does not keep any record. Consequently, it cannot - and in any event would not want to - share such information," says Kovács.

In a meeting with his counterpart, Professor K.C. Chan, the territory's secretary for financial services and the Treasury, Kovács stressed the Commission's intention is to see that Hong Kong gives the EU the chance to tax its residents according to its own tax law. "I emphasised it would strengthen Hong Kong's position as a reliable partner, since it itself had accepted the principle of transparency and sharing information on taxation matters at the OECD conference in Melbourne in 2006," says Kovács.

To this request, Kovács received a polite, but firm, "no." Hong Kong, Chan argues, won't change its laws in a way that will harm the business environment. To which Kovács pointed out that the savings directive covers only EU residents so it's not actually involved in business at all. Furthermore, since Chan hinted at his intention to sign an agreement on double taxation with EU member states, Kovács said he offered "to make an informal inquiry among member states whether it would boost their readiness to sign an agreement preventing double taxation if Hong Kong was to join the savings directive."

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INTERVIEW: The taxman cometh - Kovacs battles against VAT fraud

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