Countering VAT Evasion Methods

Examples of VAT Evasion Schemes

Creation of VAT evasion schemes pursues several goals:

1. To move money out of the legal field.
2. With the help of fictitious schemes to optimize the taxable base and receive tax deductions and refunds.
3. To conceal the withdrawn funds from the control of tax or other regulatory authorities for their subsequent free use without paying taxes.

Uncontrolled use is spending the withdrawn funds for the payment of wages, personal consumption, or for corruption. Fraudsters may use cash, cryptocurrencies, or international withdrawals to achieve uncontrollability.

When conducting transactions in such ways, it is possible to reduce VAT and taxable income, and when using “gray” money to pay salaries, entrepreneurs also save on payroll taxes and insurance premiums.

To implement the gray schemes of VAT minimization and withdrawal of funds, they create a chain composed of several links between sellers and buyers. The first link is the beneficiary—a company that, seeking to reduce the taxable base, writes off fictitious expenses and gets a tax deduction.

The last link is the terminal company, which is a fake supplier of goods, works, or services and does not pay VAT on the fictitious profits. There can be several technical companies in between, to stretch the chain and blur the apparent connection between the terminal company and the beneficiary. In this way, the fraudsters hope to avoid claims and suspicions from the tax authorities.

The invoice chain is simple: it begins with a fictitious purchase by the beneficiary and ends with a fictitious sale by the terminal company. After a series of transactions through all the links in the chain, the terminal company does not file a VAT return. Then tax authorities block its accounts, or it files a zero VAT return, and authorities should extend its life cycle by the period of an audit.

For a certain period after completing the transactions, technical companies may pretend to conduct normal business activities to confuse auditors and hide traces leading to the beneficiary. So, they file returns and pay taxes while trying to maximize deductions to minimize tax losses. At these stages, they lose some money to serve the imitation of business activity.

At some point in the chain, the visible flow of VAT and payments breaks down. This can happen at the terminal company: it accepts payment for a fictitious sale, does not file a VAT return and withdraws the money before authorities block the current account. It also can take a fictitious invoice from the “seller” for deduction but does not pay it and withdraws the money.

There are several ways to withdraw money:

• Cash withdrawal from a bank account.
• Payment for an import contract (“false import”).
• Payment for goods or services of a sole proprietorship followed by cash withdrawal.
• Payment for goods (e.g., scrap metal) or services for individuals.

The Role of Financial Institutions in Tax Optimization Schemes

The key player in the structure of the withdrawal scheme is the credit institution. It sees all transfer, deposit, and withdrawal transactions. The terminal or technical company cannot make these payments and withdrawals without data verification and approval from the financial institution. In this regard, someone can speculate that credit institutions themselves could be among beneficiaries of such schemes.

By implementing tax control measures, authorities identify such terminal and technical companies and cease their activities. However, they might already have left with their money, and new terminal and technical businesses have taken their place. Fraudulent operations continue while the terminal or technical company—rather than the credit institution that supported the execution of these methods—remains responsible for the illicit VAT optimization and money withdrawals. Attempting to unwind the tangle of the optimization scheme to the beneficiary requires the evidence of his connection with the terminal company.

This task lies on the shoulders of the tax authorities and requires a lot of effort and time.

On the side of the tax and other regulatory authorities, post-control of VAT optimization conducted by a taxpayer will not have strategic success and can only yield small short-term victories. A strategy that can solve the problem of illegal tax optimization is to limit the access of a credit institution and its clients to the management of cash flows or to bring the credit institution into the accountability when tax authorities reveal a fictitious tax optimization scheme.

Methods to Combat VAT Optimization Schemes

VAT Tax Accounts

The obvious way to limit the access of a credit institution to the management of tax cash flows is to split the payment into its body and tax. Then, without the involvement of the credit institution, the tax amount goes to a special deposit account in the treasury or the bank. A taxpayer cannot withdraw cash from these accounts and can only spend it for paying taxes.

We call this approach the fourth generation of VAT administration, which taxpayers cannot hack or cheat. It has only one significant disadvantage: taxpayers must freeze money in the amount of VAT, thereby reducing their working capital. It is also possible to enforce credit organizations’ responsibility for participation in tax optimization schemes by using the following methods.

Fines for Servicing Terminal and Technical Companies

Providing banking services to such companies can lead to serious penalties and serve as a reason for the Central Bank to revoke the license.

Credits vs. Tax Deposit Accounts

To unlock funds for bona fide taxpayers, banks can offer preferential credits against amounts deposited in tax accounts. For all incoming and outgoing payments, taxpayers must keep records for the invoices they issue to clients, and the invoices they receive from the sellers. If it is a bona fide customer of a credit institution, the bank can provide the standard factoring services.