Beware crafty VAT fraudsters who will hide in plain sight

While companies may be dragging their heels about preparing for the imminent introduction of VAT across the region, criminals will be ensuring they are ready on time

Surveys suggest that only about 20 per cent of organisations are taking any significant measures to become value added tax (VAT)-compliant ahead of its introduction on January 1 in the UAE. However, what I am certain of is that criminal elements are likely to be far more circumspect in their preparations. 

VAT has been around long enough to breed a menagerie of fraudsters who have long since flown the coop. One (single) notorious case from the UK involved a Dh832 million fraud. While its ringmaster was sentenced to 17 years in prison, his finance director, Zafar Chisthi, absconded to Pakistan. He was sentenced to 11 years in prison in absentia.

With an Interpol warrant for his arrest, are others like him now preparing to take advantage of regional VAT launches? What would these frauds look like? Today is not about the small-timer who claims VAT back on a printer purchased for personal use. TV series are made about the people I want to discuss, so let’s examine how frauds are executed and what might be done to counter these nefarious tax crackerjacks.

Anaesthetised by television series and films, most now barely believe in the Mission: Impossible-style preparations of conspirators. Approaches used in reality are, sadly, often much simpler and, sadder still, more effective.

The inception of VAT fraud typically relies on some form of patsy. This might be an unsuspecting foreign entity; its corporate branding and individual contact details cloned. Criminals might use an entity that does not trade in the UAE, but has a commercial footprint elsewhere. This would be leveraged to create legitimacy in the UAE, even though the true entity is not involved.

Utilising that identity, minimal business relations are established. Given that the purpose is not to trade but to extract the maximum amount of money from fraudulent VAT repayments, time is of the essence.

VAT refunds will typically trigger a Federal Tax Authority (FTA) audit. Anticipating this, criminals might appoint a local accounting firm as support in some minor aspects of their business. With elementary exposure to its supplier and customer invoices, they are deployed to add operational credibility in convincing the FTA that all is well. The accounting practice is likely being additionally deluded with promises of an expanded engagement.

Classically, goods are typically traded through multiple shell companies to give the impression of a normal supply chain in motion. One situation I looked at saw the paper trail complete its journey in just five days. This is more commonly known as carousel fraud.

I spoke with Danny McLaughlin, a noted forensic fraud investigator, and he said: “Sometimes leases are taken in multiple warehouse locations, the goods moved from one to another to support any notified audit. These goods are never actually sold to an end customer, indeed they might not even have been paid for.

Sometimes it may be possible to perpetrate such fraud even where no actual goods exist; so called virtual transactions involving only paperwork.”

Eventually the entities collapse and the fraudsters, along with the government’s VAT monies, disappear.

The other main type of VAT fraud involves the manipulation of invoices, typically under declaring sales and accounting for purchases multiple times.

There is longevity when this method is employed. By skirting along the fringe of what VAT might be expected to be paid, authorities compute industry norms, they can shelter under the radar for a long time.

Punishing captured criminals is a tricky balance in these cases. Besides custodial sentences for engaging in VAT fraud, a further objective must be to recoup all the monies stolen. One method is the use of default prison sentences.

These are tapered lengths of time that penalise the shortfall in the monies not recovered. Should the liquidated value of the fraudsters assets prove insufficient to satisfy the amount owed, future assets could also be confiscated.

Within a single country environment, VAT fraud can be contained at very manageable levels. The creation of the GCC VAT zone with each members’ differing administration approaches and peculiarities with regard to the rules, it is difficult to see, without harmonisation of approach, how it avoids the explosion of fraud that the EU experienced in the wake of the 1993 abolition of internal customs barriers.

Conceptually, VAT, well sales tax certainly, is a fairer method of taxation as it only applies at the point of consumption. It's open to monstrous levels of fraud, but salvation might be in the offing by way of the Portuguese experience and something I believe Saudi Arabia might be planning.

If all VAT transactions at the point of sales were mirrored to a government mainframe, the VAT number of both the supplier and customer noted, the fraudsters would need to retreat to their lairs and develop new game plans.

The Economist once mooted the level of EU VAT fraud at circa Dh419 billion.

My hope for the GCC is that it will take particular exception to those that systematically steal from governments that need the income to invest and develop in their people’s futures.

David Daly is a chartered accountant (Cima) who leads a consultancy practice in the UAE

Read more: VAT in Saudi Arabia and the UAE - how do they compare?