Countering cross-border VAT
fraud: the Bulgarian experience
Konstantin V. Pashev
New Bulgarian University and
Center for the Study of Democracy, Sofia, Bulgaria
Abstract
Purpose – The paper sets out to study value added tax’s (VAT’s) exposure to missing-trader or
carousel fraud and possible countermeasures, their costs and benefits.
Design/methodology/approach – It studies the modus operandi of network fraud by distinguishing
it from individual evasion. Drawing on the experience of Bulgaria, it discusses the costs and benefits of
the principle of joint liability and of the VAT account, the latter being tried so far only in Bulgaria.
Findings – The study concludes that the possible solutions are in the field of optimizing risk
management and the application of the principle of joint liability rather than through tighter controls
at entry and on the conduct of business.
Originality/value – Confronted with the drastic increase of carousel fraud, the European
Commission identified the urgent need of a coherent strategy to combat it. Yet, neither the
literature nor the practices of tax and law enforcement have addressed the threat adequately. Tax
evasion literature is focused on the drivers and deterrents of individual evasion, while studies of VAT
network crime rarely consider the preventive instruments’ extra compliance costs for taxpayers. In
this context, Bulgaria’s unique experience with the VAT account provides useful insights to policy
makers about its limitations and the application of the joint liability principle.
Keywords Fraud, Value added tax, International business, Bulgaria
Paper type Case study
Among the deficiencies of the value added tax (VAT) is its exposure to cross-border
network abuse of the credit mechanism known as missing trader or carousel fraud.
Confronted with the recent sharp increase of the fraud, estimated at about e60 billion a
year, the European Commission identified the urgent need for a coherent strategy to
combat it by going down to the very fundaments of the VAT, the credit system. The
commission backed the introduction in the UK of the so-called “reverse charge method” in
regard to such fraud-prone goods as mobile phones and computer chips; and considered to
work on a directive allowing its broader use by the member states (EcoFin, 2006).
In the four decades of its use in Europe, the credit-invoice type of VAT had turned
into a major policy vehicle of fiscal management and free trade. There is however a
basic contradiction in the tax. On one hand, the VAT is crucial for the very fundaments
of the single market, i.e. the free movement of goods, capital and people. On the other
hand, it is exactly the integration and the establishment of the single market, which
brings the tax closer to a sub-national tax, for which it is not best suited. There are two
problems of the VAT operation across tax jurisdictions. Firstly, it is its vulnerability to
fraud. Secondly, the smooth and fast operation of the refund mechanism is crucial for
taxing consumption rather than production or investment and exports. The latter
depends on how fraud-proof the refund mechanism is; and on the harmonization of tax
rates and tax bases in the member states; as well as on the degree of cooperation
between their revenue and law-enforcing agencies.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1359-0790.htm
JFC
14,4
490
Journal of Financial Crime
Vol. 14 No. 4, 2007
pp. 490-501
q Emerald Group Publishing Limited
1359-0790
DOI 10.1108/13590790710828190