Making third parties liable for their clients' unpaid VAT is unjust and counter-productive

IN the run up to Christmas, VAT twice became the focus of intense media attention. First there was the controversy about VAT on sanitary products, where the revelation that tampons are considered for VAT purposes a ‘luxury’ item, and are therefore taxable, caused outrage among feminist campaigners. And soon afterwards the BBC and The Guardian were leading with stories about how the warehousing arrangements of Amazon and eBay were depriving HMRC of hundreds of millions pounds of VAT.

‘Tampongate’ was in some ways an old fashioned dust-up about VAT rates. But the warehousing story will have profound long-term implications for companies offering business support services – internet sales platforms, accountants, logistics providers and freight forwarders; all these and more could be affected and potentially liable for their clients’ VAT.

It was surprising to see VAT in the headlines because VAT is not sexy. The truly front-page taxes are income and corporation – apparently unambiguous indicators of a society’s values. The Hollande presidency in France has, for example, been permanently tarred as anti-entrepreneurial for its 75% top rate of income tax; George Osborne, on the other hand, seen as a rich man helping out his class, nearly scuppered his career when he dropped our top rate to 45% in 2012. And when Amazon and Starbucks were discovered to have extremely thorough international corporation tax planning, startled looking financial managers were hauled before the House of Commons Treasury select committee for a full spectrum scolding.

These are the taxes to stir up political frenzy: they slot into recognizable ideological narratives of, on the left, evasion by greedy irresponsible plutocrats; or, on the right, theft and misappropriation by overweening and inefficient governments.

The politics of VAT are, by contrast, complex: a tax on consumers, but charged by businesses, it is regressive (everyone pays the same rate, prince or pauper), which is why the left, which likes tax, has been wary of it; while the right – skeptical about taxation in general – especially dislike the way that the costs of collection are largely dumped on businesses.

‘Nobody likes it, and nobody understands it’, as one financial journalist put it to me; and this is probably the reason it has been so successful for governments as a source of revenue. VAT is under the radar. There will be the occasional inchoate furore – sausage rolls, tampons – but it is not a mainstay of the political ‘conversation’.

Last year, HRMC collected more than £100bn in UK VAT: the number could rise to £110bn this year. Across Europe, 2013’s (the last year for which we have a detailed breakdown) overall VAT take was €933bn (£693bn) These are staggering numbers: VAT now accounts for around 20% of overall UK government revenue, dwarfing corporation tax as a source of income.

VAT is Europe’s gift to taxation; France and Germany both claim to be responsible for its development. Historically, it has been – from a collection perspective – the most effective indirect tax yet devised. Fittingly, it is the tax that defines the European Union: having a VAT system, with rigid parameters for rates (centrally determined by Brussels – a fact of which anti ‘tampon tax’ campaigners seemed generally unaware) is a prerequisite for EU membership. Indeed, US Republicans have resisted the adoption of VAT because they believe it to have financed the European welfare model.

It is also – something little understood – what funds the European Union. The majority (68% in 2014) of the EU’s own funding came directly from member state VAT receipts. All member states contribute a predefined proportion of VAT revenue: the higher the total European VAT take, the more money that sloshes around Brussels. The UK is forecast to contribute £2.5bn of VAT to the EU in 2015-16. (It’s surprising to me that neither UKIP nor the Leave EU campaign has made a serious attempt to politicize this fact. But there you are: VAT just isn’t sexy).

The centrality of VAT to the EU project is the reason for the extreme alarm of the European Commission at growing evidence of the VAT system’s vulnerability. (The concern is so great that the EU’s VAT Commissioner has publically speculated about the possibility of VAT being abandoned and replaced by a simplified sales tax). €933bn was collected across the EU in 2013; but, on the basis of what was rightly collectible, the take ought to have been €1.1trn – a single year ‘VAT Gap’ of €167bn: well in excess of the UK’s whole annual VAT revenue.

It is the VAT gap that is ultimately behind the warehousing story. The allegation – made in the House of Lords by Lord Lucas – is that the new online marketplaces are ‘collaborating’ with overseas traders by turning a blind eye to their lack of VAT compliance. (This is factually inaccurate: Amazon does provide extensive guidance about EU VAT compliance, and works with providers to assist their clients. The issue is the complexity of the system). Lucas identified small Chinese companies as a particular problem: they don’t charge VAT, and don’t pay it – defrauding HRMC, and putting UK competitors at a disadvantage. Lucas was clear about the solution: Amazon and eBay ought to be liable for their clients’ VAT.

Though new to the UK, this is part of a trend towards what leading VAT academic Rita de la Feria calls ‘responsibilisation’: making third party providers liable for their clients’ unpaid VAT. How much easier, after all, to pursue Amazon, than to find a way of dealing with all those Chinese firms. But Amazon is just the tip of the iceberg; European tax authorities have attempted to recover unpaid VAT from the – totally independent – owners of warehouses who happened to be holding the stock of a VAT avoiding company. And the principle of holding an innocent third party responsible, on the basis that they ‘ought to have known’ is becoming standard practice when dealing with massive ‘carousel’ frauds. European tax authorities , laboring under austerity, are desperate for money, and are willing to take it where they can find it.

It is critical for third-parties to understand that the issue is not merely theoretical, even in the UK: The Guardian reported last week that HMRC had raided warehouses believed to contain ‘VAT-free’ goods just before Christmas, seizing at least £500,000 worth of items. Indeed, given that the outgoing Head of HMRC last week expressed skepticism about Amazon’s direct liability during parliamentary hearings, it may well be that HMRC – and other authorities – plan to target smaller players first.

Professor de la Feria, who is the new professor of tax law at Leeds University, has been scathing about some applications of the ‘responsibilisation’ principle: firstly, it is patently unjust: why should third parties be held accountable for the failings of their clients? Secondly, it is massively counter-productive. If fraudsters know that tax authorities will pursue soft third party targets for missing revenue, what is the deterrent against committing fraud?

Nonetheless, the principle is being established, and the trend will almost certainly continue. The EU’s Mutual Assistance Recovery Directive is enabling EU tax authorities to cooperate efficiently in the pursuit of unpaid foreign VAT. Cross-border audits, fines and penalties are becoming more and more common. Clients will expect advisers and providers helping them to trade cross-border to have established a system for getting them compliant. And if their clients don’t pay the right people at the right time, the advisers themselves could be hearing a knock at the door – or receiving an email from an unfamiliar and unfriendly tax authority.

Nicholas Hallam is chief executive of VAT consultancy Accordance