Anti-Fraud Measures in the Czech Republic: Conflict and Controversy

August 1, 2016 Charles Riordan

The principle of open borders between European Member States, leading to a single, united economy, is at the very heart of the European Single Market, including the Czech Republic, which is a member. But the lack of cross-border trade barriers has hidden drawbacks. Since its inception, the Single Market has been vulnerable to a type of fraud that exploits the reduced oversight inherent in intra-Community trade – and this so-called “missing trader” or “carousel” fraud, which targets value-added tax (VAT), is estimated to cost Member States roughly 50 billion Euros in revenue each year.

Finance Minister Andrej Babiš of the Czech Republic has recently embarked on a targeted campaign to eliminate VAT fraud in his country. To this end, the Czech Republic has overhauled its national VAT laws, and introduced stricter reporting requirements for domestic suppliers. But the Czech campaign has not stopped at the country’s borders; instead, Minister Babiš has challenged the European Council to develop and test a controversial new means of collecting VAT, which would represent a major derogation from EU law.

“Missing Trader” Fraud and Cross-Border Trade

In its simplest form, “missing trader” fraud occurs when a business collects VAT on a supply of goods, and then ‘disappears’ without paying the VAT to the tax authorities. The legal framework for the intra-Community acquisition of goods facilitates this type of fraud. Under Article 200 of Council Directive 2006/112/EC (the “EU VAT Directive”), a business making an intra-Community acquisition of goods is liable for VAT in the Member State of acquisition. This means that VAT on intra-Community acquisitions is self-assessed via a VAT return, rather than paid to the supplier. Unfortunately, this provision makes it easy for “missing traders” to withhold the VAT that should be self-assessed on the acquisition, in addition to the VAT collected on a subsequent sale of the goods. More sophisticated variants of this fraud have also been developed and have resulted in even greater losses for governments.

The Czech Republic’s Stance

The Czech Republic has introduced a number of measures to combat “missing trader” fraud. A new reporting form called the “VAT Control Statement,” which is used to identify suspicious transactions, was introduced by the Ministry of Finance in January of 2016. More recently, Parliament approved an amendment to the national VAT Act directed against “missing traders” with no physical presence in the country.

But the most ambitious measure by far is a proposal to institute a generalized “reverse charge mechanism” (RCM) program within the Czech Republic. The RCM would shift liability from the supplier to the customer at all levels of the supply chain, and remittance of VAT would only occur upon a sale to a final consumer (i.e., a non-taxable person). Under this system, suppliers would not collect VAT on sales within the supply chain, and “missing trader” fraud would, in theory, be eliminated. The RCM proposal, however, is completely inconsistent with the EU VAT Directive, and cannot be implemented without the unanimous consent of the other Member States.

Conflict with the European Council

To win support for the RCM, Minister Babiš has engaged in fierce negotiations with the European Council, at one point threatening to withhold his support for a package of high-profile corporate tax avoidance measures. This resulted in a written commitment by the European Commission to present draft RCM legislation at a future Council meeting. What this means for a future RCM program is unclear, as serious opposition still exists among the other Member States. But Minister Babiš has clearly succeeded in pushing the issue to the top of the EU’s agenda on VAT.

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