Umsatzsteuer, Steuerstraftat, Steuersystem, Sales tax, Tax system

Andrea Gebauer

Hans-Werner Sinn

Rüdiger Parsche

English

Research Papers in Economics

THE IFO INSTITUTE’S MODEL
FOR REDUCING VAT FRAUD:
PAYMENT FIRST,R EFUND
LATER
HANS-WERNER SINN,
ANDREA GEBAUER AND
RÜDIGER PARSCHE
In 2003,the tax authorities lost almost q18 billion1 in
value added tax (VAT) revenue due to fraud and
bankruptcies. This figure was calculated by the Ifo
Institute by comparing actual revenues with those
that would theoretically accrue on the basis of infor-
mation by the Federal Statistical Office on private
consumption and non-taxable items (see Dziakowski
et al. 2002).
As far as fraud is concerned, the calculated losses
can be traced to activities in the underground econ-
omy as well as various versions of open tax fraud,
where invoices are drawn up.This includes primarily
input tax fraud including the so-called carousel
deals.This paper deals with ways to prevent revenue
losses due to tax fraud and bankruptcies.2
If VAT losses could be prevented, the authorities
would receive estimated additional revenue of
q6.5 billion. This would constitute a non-negligible
contribution to a reduction of the fiscal problems of
the various levels of government.In fact,the figure is
twice the revenue from the inheritance tax and
exceeds by half the potential revenue from a wealth
tax,assuming the same conditions as in 1996,the last
year in which this tax was levied. Germany would
also be in a better position to meet the debt ceiling
of the EU Stability and Growth Pact. The share of
net borrowing in gross domestic product would fall
by more than 0.3 percentage points.
What explains the revenue losses?
One of the major causes of the revenue losses is in-
put tax deduction. In the present system, the seller
presents the buyer with a bill showing the VAT, and
the buyer can deduct the VAT from his tax liabilities
if he is eligible for input tax deduction. This may
even lead to net refunds if input tax entitlements
exceed the VAT owed on one’s own sales.The refund
of the input tax is independent of whether and when
the bill is paid and also independent of whether the
seller has paid over the VAT shown in the bill to the
tax authorities.It further does not matter whether or
not the buyer has received sales revenue that is sub-
ject to VAT and must therefore pay VAT himself.
Since investments are VAT free, the refund of the
input tax that is independent of one’s own tax pay-
ment is an essential element of the VAT.
This procedure leads to an undesired loss of revenue
if the buyer demands the refund of the input tax by
presenting a bill, but fails to pay the bill because of
bankruptcy. Tax losses also occur when the seller
fails to pay over the VAT, which the buyer has
already paid as part of the total sum billed, either
because he himself goes bankrupt or because he
does not declare the revenue subject to VAT on his
tax statement.
Tax defrauders have thought of a multitude of tricks
for taking advantage of loopholes in the system.
Especially profitable are carousel deals. These are
deals in which a good is actually or at least on paper
shifted several times between several firms in order
to qualify for fraudulent input tax refunds. Cross-
border transactions frequently play a role in this
because they make tax-free imports or exports pos-
sible and make controls by the tax authorities more
difficult.
For example, mobile phones are imported from
abroad and sold to a domestic commercial firm which
ships them back to the initial shipper. The importer
may buy the mobiles tax-free according to the present
country of destination principle. By selling them to
the domestic commercial firm,he includes the VAT in
the invoice but does not pay it over to the tax author-
ities. The commercial firm receives the input tax
refund and sells the mobiles tax-free to an importer in
a foreign country. From there the good may be sent
again to Germany and the carousel keeps going
round and round. By the time the tax authorities
detect the scam and try to collect the VAT from the
importer, the participating firms have, as a rule, dis-
solved and the owners cannot be found.
CESifo Forum 2/2004 30
Special
1 This figure is subject to considerable uncertainty at the present
time,as it is based entirely on estimates of the Ifo Institute.In addi-
tion, tax losses due to recent decisions of the European Court of
Justice, which may amount to q1.5 billion, have not been included.
2 Underground economy activities are not considered here.
Measures to fight moonlighting range from a change of the welfare
system (see Sinn et al. 2002), which withdraws labour from the
underground economy, to radical tax cuts (see Sinn et al. 1999),
which generally lowers the attractiveness of moonlighting.CESifo Forum 2/2004 31
Special
In order to contain the abuse, the law to reduce tax
deficiency was passed in 2002 which among other
things provides for the buyer’s liability for the sell-
er’s culpable failure to pay over the VAT.
Neither did the new law achieve the expected addi-
tional tax revenue of q2.5 billion, nor did it effec-
tively prevent carousel deals.
This is firstly due to the fact that to date a buyer is
only liable for the seller’s culpable failure to pay
over the VAT if he knew of the latter’s intention to
cheat at the time the deal was struck, which is, of
course, difficult to prove. Secondly, the law remains
ineffective if not only the seller but also the buyer
fails to pay over the tax.
Among the measures included in the law is one that
demands collateral of newly established firms,
because in a large number of cases firms were only
established for the purpose of VAT fraud.This mea-
sure, too, proved ineffective because the people
reacted swiftly by “stocking up” on newly estab-
lished firms. In addition, such firms are increasingly
abused for carousel deals that had been in the mar-
ket inconspicuously for years in order to give the tax
authorities the impression of orderly management.
Only the VAT follow-up,i.e.unannounced tax audits,
seem to have achieved some success in reducing tax
fraud.According to the estimates of the Ifo Institute,
tax losses due to fraudulent carousel deals and bank-
ruptcies amounted to q5 billion in 2003, despite the
law to reduce tax deficiency.
A solution proposed by the Ifo Institute
In order to solve the problem, the Ifo Institute pro-
poses a modified value added tax procedure, which
legally remains as close as possible to the present sys-
tem,but prevents fraud effectively.It makes sure,first-
ly, that the buyer does not receive an input tax refund
that had not been previously paid as VAT to the tax
authorities, and secondly, that the VAT included in a
bill is indeed paid over to the tax authorities when the
bill is paid by the buyer. The buyer of a product may
only claim the input tax deduction if he can prove that
the seller has already paid over the VAT to the tax
authorities, and the seller must pay over the VAT to
the tax authorities at the same time at which he col-
lects the VAT with payment of the bill. In this way,
some frauds which are possible in the present system,
and especially the carousel deals, are prevented.
In addition, possible tax losses resulting from bank-
ruptcies are also largely prevented. Thus, the seller
can no longer escape passing on the VAT collected in
the case of bankruptcy, and it is impossible for the
buyer to have the input tax refunded as a liquidity
reserve without ever paying his bill.
Two procedures may be used to achieve these
effects, depending on whether the sale is in cash or
non-cash.
1. Non-cash payment (trust account)
If a bill is paid by bank transfer or by credit card,the
amount of VAT, which is shown separately when
payment is made, is directly passed on to the tax
authorities. Toward this end, the bank involved acts
as a trustee for the tax authorities. In detail the pay-
ment process can be explained as follows:
(1) As part of his business, the seller sells a good or
a service to the buyer.
(2) He ships or presents the good. If it is not paid
immediately, the good is accompanied by a bill
of sale that includes the seller’s tax number and
the number of the bill of sale.
(3) The seller charges the buyer the agreed price
plus VAT and notes the number of the bill and,
as the case may be, the number of the bill of
sales and his tax number.
(4) The buyer pays his bill plus VAT by bank transfer
or credit card with the number of the bill, the tax
number of the seller and his own tax number.
(5) The amount paid is always transferred by way of
an intermediate account, from which not only
the VAT is paid over to the tax authorities but
also the net amount of the bill is credited to the
seller. This special account, the VAT trust
account, is administered by the seller’s bank as
trustee to make sure that the VAT is paid over
to the tax authorities.
(6) In non-cash transactions, the seller hands over
to the buyer a receipt for the gross amount
received and, in addition, a receipt for the VAT
paid over. In credit card transactions, the corre-
sponding information is printed out on the
buyer’s record. In bank transfers, the bank
makes out a record of transfer that contains all
the necessary information.
(7) With the record of VAT paid the buyer can now
claim the input tax from the tax authorities in
the same way as it is done today. If fraud is sus-
pected, the tax authorities can check with thehelp of the printed tax numbers of the parties to
the transaction and the number of the bill
whether the VAT payment has actually been
made.
2. Cash payment (tax stamp system)
To also make sure in the case of cash payments that
the tax authorities receive the VAT due on the pur-
chase price, a prepayment of VAT by the seller is
planned. For this there are two possibilities:
a) The seller has a machine with which he
stamps the receipt with the amount of VAT in
question.This machine,which is connected to
the telephone line,works like the well-known
postage machines of the Postal Service and
contains a kind of account, which the seller
has “filled” in advance with payments to the
tax authorities and against which the
stamped VAT amounts can be debited. The
tax credit in the machine account can be
granted by telephone as in the case of
postage machines.
b) For the few sellers who will not have a VAT
machine and in special cases,a tax stamp system
is planned.The seller buys tax stamps in advance
directly from his tax authority, the printed
amounts on the stamps being graduated like the
amounts on notes and coins. This way any
amount can be affixed. This is the system fol-
lowed by tobacco stamps.
In detail, the cash payment system works as follows:
(1) As part of his business, the seller sells the buyer
a good or service.
(2) The buyer pays the sales price plus VAT.
(3) The seller gives the buyer a receipt which con-
tains the receipt number,the seller’s tax number
as well as a printed or affixed VAT receipt.
(4) If entitled, the buyer claims his input tax refund
with the help of the VAT amount contained in
the receipt.
(5) It he is not entitled to an input tax refund, he
must still take the receipt. He must have the
receipt on him when leaving the store.
The payment model can be considered an extension
of the Italian Scontrino model. In Italy, no buyer
may leave a store without a receipt. As a rule, the
receipt is printed in standardised form by the auto-
matic cash register, owned by even the smallest
stores.The Scontrino System registers only the VAT
to be paid, however, without implying an advance
payment.
By connecting the cash register to an account of
the tax authorities, from which the virtual VAT
stamps can be downloaded, a VAT system for cash
transactions is created that prevents input tax
deduction without prior VAT payment as well as
non-payment of the collected VAT to the tax
authorities by the seller. The new cash payment
system has the additional advantage that it gener-
ally makes transactions in the underground econo-
my more difficult.
As shown by the Italian example, it is easily and
effectively possible to check whether someone has a
receipt or a bill of sales when leaving a store. In this
way, a greater measure of discipline in cash transac-
tions in stores may be generated. Italy has always
had much greater problems of collecting taxes than
the German tax authorities (see Nam et al. 2001).
Therefore that country has felt the need to fight VAT
fraud much earlier. The Italian experiences can and
should be utilised.
Why the Ifo proposal is better than the 
reverse-charge procedure
A long discussed alternative to the present sys-
tem, which is to prevent the present VAT losses, is
the so-called reverse-charge procedure (see
Ministry of Finance 2003).With this procedure the
tax liability is transferred to the buyer, and his
input tax claim is directly balanced against his
VAT liability.As the result, the shipment between
two firms remains tax-free.The entitled buyers are
assigned a special identification and entitlement
number, the so-called R-number.3 An electronic
system is supposed to let the seller check the R-
number online in order to make sure that the shift
of the tax liability and balancing takes place only
if the buyer is firm entitled to claim the input tax
refund. To be sure, the R-number may only be
used for purposes that do not preclude an input
tax deduction. Furthermore, the reverse-charge
system is not applied to negligible transactions,for
example up to q1,000, and probably not to cash
transactions.
CESifo Forum 2/2004 32
Special
3 The concept of an R-number is used in recent publications on the
reverse-charge system.CESifo Forum 2/2004 33
Special
The seller must report the concluded sales online
and must also itemize his receipts in the annex to the
advance value-added tax return, according to
whether they are from entitled or not entitled buy-
ers. The buyer must keep a record of the use of his
R-number.
Like the Ifo model, the reverse-charge system also
largely prevents carousel deals and tax losses due to
bankruptcy that are based on claiming input tax
refunds from the tax authorities without ever having
paid the tax.However,the reverse-charge system has
at least four important disadvantages compared to
the Ifo proposal.
Firstly, the reverse-charge system promotes the
crime of shifting private expenditures to the busi-
ness. Carrying private expenditures on the books of
the business is already a widely practiced fraud at
present. But at least he who wants to get input taxes
refunded must actively file a claim with the tax
authorities.With the reverse-charge system purchas-
es of consumer goods may be assigned to the busi-
ness from the start and in this way be exempted from
VAT.This greatly facilitates fraud.
Secondly,the reverse-charge procedure increases the
probability of VAT fraud in transactions with final
consumers. For example, a firm which is in financial
trouble may buy goods at net prices and sell them at
gross prices, i.e. including VAT, to final consumers
without paying over the VAT. Via an excessive vol-
ume of transactions, it can generate liquidity in this
way without involving the tax authorities and raising
their suspicion. In case of flight, the VAT collected is
as a rule lost to the tax authorities.
In the Ifo procedure, this risk is small. In order to
generate liquidity in the same way, the final con-
sumers and the tax authorities must be party to the
fraud.The former would have to do without a bill,as
payment per bill requires paying over the VAT. The
latter would have to refund the input tax without
becoming suspicious of the excessive transaction vol-
ume. Fulfilling both conditions at the same time
should be most difficult.
A milder form of this disadvantage of the reverse-
charge system occurs in the case of simple bankrupt-
cy that is not preceded by an excessive transaction
volume and is absent a fraudulent intention. If the
firm supplying the final consumer goes bankrupt
immediately after the sale of the goods, the tax
authorities as a rule lose the entire VAT collected at
the final sale. In the Ifo procedure, this possibility is
at least precluded if the consumers are honest and
buy only with a receipt.The firm can claim the input
tax refund from the tax authorities, but it cannot sell
to the consumers in a regular way without at the
same time paying over the VAT on the value of the
goods.
Thirdly, the introduction of the reverse-charge sys-
tem could imply parallel systems, as the seller would
have to differentiate his buyers according to whether
they are entitled to an input tax refund or not. In
contrast to the present system and the Ifo proposal,
the seller would have to know the status of his cus-
tomers and could no longer ask for the payment of
VAT on each sale. The negligibility rule and the
exclusion of cash sales, which are important charac-
teristics of the reverse-charge procedure, also add
complications.
Fourthly, before the reverse-charge system can be
introduced, considerable resistance on the EU level
will have to be overcome.In view of the similarity of
the Ifo procedure to the present system,the required
approval by the European Commission of such a
modification of the system may be expected much
rather than that of a reverse-charge system.
Concluding remarks
The value added tax replaced the cumulative all-
stage turnover tax in the 1960s.While it has many
theoretical advantages, its collection has proven
more difficult over time than expected.Especially
the present practice of input tax refunding is high-
ly problematic.It has invited fraud.The volume of
fraud charges has reached such an extent that the
state must act without delay in order to stop a fur-
ther erosion of one of its major taxes.This contri-
bution shows a way to prevent VAT fraud and to
safeguard the tax revenues of the state. In times
of scarce financial resources, the state should not
hesitate to implement the proposal presented
here for an improvement of the value added tax
system.
References
Working group “Business games”at the Ministry of Finance (2003),
“Changes in the Collection of the value added tax for the preven-
tion of tax fraud and tax losses in the business chain,” Discussion
Paper to be presented to the European Commission, Berlin.Dziardkowski, D., A. Gebauer, W.Ch. Lohse, Ch. W. Nam and R.
Parsche (2002), “Entwicklung des Umsatzsteueraufkommens und
finanzielle Auswirkungen neuer Modelle bei der Umsatzbesteue-
rung,” Ifo Research Reports, No. 13, Munich.
Nam, Ch..W., R. Parsche and B. Schaden (2001), “Measurement of
the Value Added Tax in Selected EU Countries on the Basis of
National Accounts Data,” Ifo Studien 47, 127–144.
Sinn, H.-W. (2003), Ist Deutschland noch zu retten?, Econ, Munich.
Sinn, H.-W., Ch. Holzner, W. Meister, W. Ochel and M. Werding
(2002), “Aktivierende Sozialhilfe: Ein Weg zu mehr Beschäftigung
und Wachstum,” Ifo Schnelldienst 55 (9), 3–52.
Sinn,H.-W.,W.Leibfritz and A.Weichenrieder (1999),Ifo Vorschlag
zur Steuerreform,“ Ifo Schnelldienst 52(18), 3–18.
CESifo Forum 2/2004 34
Special

Entwicklung des Umsatzsteueraufkommens und finanzielle Auswirkungen neuer Modelle bei der Umsatzbesteuerung,” Ifo Research Reports,

Ist Deutschland noch zu retten?,

Measurement of the Value Added Tax

Working group “Business games”at the Ministry of Finance

The Ifo Institute’s Model for Reducing VAT Fraud: Payment First, Refund Later

http://www.cesifo-group.de/portal/page/portal/DocBase_Content/ZS/ZS-CESifo_Forum/zs-for-2004/zs-for-2004-2/forum2-04-specials1.pdf

The Ifo Institute’s Model for Reducing VAT Fraud: Payment First, Refund Later

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics