VAT reverse charge mechanism: preventing VAT fraud

The Council is working on a proposal for a Council directive which aims to allow the application of a generalised VAT reverse charge mechanism to domestic transactions between businesses involving services or goods with an invoice exceeding €10 000. The application of the mechanism would be allowed under certain conditions.

The reverse charge mechanism moves the responsibility for the reporting of a VAT transaction from the seller to the buyer of a good or service. 

Application of such a mechanism would constitute a derogation from the main general principles of the EU's current VAT system and therefore requires amending directive 2006/112/EC on the common system of value added tax. According to the proposal, the derogation would be granted for a limited period of time and would be voluntary for member states fulfilling the conditions set out in the proposed directive.

The aim is to help some member states that are particularly affected by VAT fraud and do not have sufficient measures to combat it, which could be the case in instances of VAT fraud schemes such as the 'carousel' or 'missing trader' schemes.

The proposed directive would offer a solution limited in time, according to which supplies would be taxed in the country of destination.

• Proposal for a Council directive as regards the temporary application of a generalised reverse charge mechanism
• Council directive 2006/112/EC on the common system of value added tax

Why was the proposal made?

The proposal was made following a request by the EU member states that are particularly affected by loss of revenue due to VAT fraud, especially carousel fraud.

According to the European Commission, the VAT gap (the difference between the expected VAT revenue and the VAT actually collected by tax authorities) in the EU has reached nearly €160 billion, of which about €50 billion is attributable to cross-border fraud (in 2013).

The possibility to apply the reverse charge mechanism exists in the current system as well; however, its application is not generalised and is limited to a certain list of sectors. Its application is also limited in time. It was introduced by EC directive 2013/43/EU.

What is 'carousel' or 'missing trader' fraud?

In the EU, carousel fraud typically involves cross-border transactions between businesses.

Under the EU's current VAT system, intra-EU business-to-business (B2B) cross-border supplies are exempted from VAT, whereas the obligation to pay the VAT to the government budget lies with the vendor of the goods and services on the destination market (the vendor is the VAT collector).

In essence, the cross-border movement of goods in the EU is split into two transactions:

• the intra-EU supply of goods is exempted from VAT
• the intra-EU acquisition of goods is subject to VAT in the country of destination, where the VAT collector is the vendor

How does a missing trader or carousel fraud scheme work?

The scheme involves several companies selling goods or services, imported VAT-free from a supplier (the so-called conduit company) in another EU country, to each other on a domestic market.

One of the companies in the chain, usually the one that imported the goods, does not pay the VAT to the state budget despite charging it to the next buyer, thus committing fraud. This company usually very quickly disappears without trace following the transaction (hence the 'missing trader'). This makes the tax collection impossible in the state in which goods or services are consumed. The other buyers in the chain, meanwhile, redeem the VAT from the state budget after selling the goods further. The goods or services may in reality not even move, or may only exist on paper.

The 'carousel' starts turning again when the final buyer in the chain on the domestic market re-sells the goods to the first supplier, i.e. the company that brought the goods into the country, allowing the whole process to start again. This last transaction, being a cross-border one, would again be exempt from VAT.

The scheme can also function on the domestic market only.

The reverse charge mechanism is a measure that shifts liability for final VAT payment to the government budget from the vendor to the customer. In this way it aims to reduce the risk of VAT fraud.

Key elements of the proposal

Legislative procedure

The adoption of the draft directive requires a special legislative procedure: a unanimous vote by the Council, after consulting the European Parliament.  The Council is not legally obliged to take the Parliament's opinion into account, but according to the case-law of the Court of Justice, it must not take a decision without having received it.

Conditions for applying the mechanism

According to the proposal, the conditions that a member state must meet to be able to apply the generalised reverse charge mechanism should be the following:

• the member state's VAT gap should be five percentage points above the median European VAT gap
• the level of carousel fraud in the member state should make up more than 25% of its VAT gap
• the member state should prove that conventional measures are not sufficient to fight this kind of fraud

The proposal further stipulates that the European Commission would have three months to authorise or reject a member state's request to apply the mechanism, depending on whether the requirements are fulfilled.

Neighbouring member states

According to the proposal, a member state that has a common border with the state applying the generalised reverse charge mechanism should also be authorised to apply this mechanism, under certain conditions.

Repealing the mechanism

The draft directive proposes that if a considerable negative impact on trade within the EU's internal market occurs after the introduction of the mechanism, it would have to be repealed, without retroactive effect, after a six-month period.

Time limit

The proposal suggests that the mechanism should be in force until 30 September 2022. It will then be assessed by the Commission.