Turnover Tax (VAT) carousels and missing traders in Germany

So-called VAT or turnover tax carousels have repeatedly led to large-scale criminal tax investigations and court proceedings in Germany in recent years. The accusation is that sales tax is not handled correctly for deliveries of goods between companies of different member states. In most cases it is disputed whether the individual entrepreneur (and, if applicable, his tax consultant) can be accused of criminal intent to commit criminal tax evasion.

1. The Role of the Missing Trader

At the heart of a punishable VAT carousel is the so-called missing trader. This is an entrepreneur who exists only on paper. This trader is integrated into a supply chain, whereby it is intended from the outset that he will not pay VAT.

From the point of view of criminal tax law, it is problematic that even completely normal, legally acting companies often do not know whether they are dealing with a “missing trader”. In principle, it is a permissible procedure to purchase goods from another trader and to have the VAT shown in the corresponding invoices refunded as input tax by the tax office.

However, a missing trader usually has no intention of really developing an economic activity. Rather, it aims to give the tax office the impression that it is an ordinary company that acquires goods from a company in another EU member state (so-called in-out buffers). These goods are immediately resold to another company in the country (so-called buffer). If necessary, several intermediate members, i.e. further buffers, are involved. At the end of the domestic supply chain there is a so-called distributor who sells the goods to a company in another EU member state.

2. Fiscal Background of Turnover Tax Carousels

When assessing the legal situation with regard to turnover tax, a distinction must be made between the various persons or functions of a supply chain:

The in-out buffer located at the beginning of the chain in another member state declares a tax-free intra-Community supply (§ 4 Paragraph 1b, § 6a UStG – German VAT Law) to the national tax authorities responsible there.

The missing trader, on the other hand, declares to the tax office that he has sold the goods to a domestic buffer and accordingly shows VAT in his invoices. However, he does not actually deliver the goods.

The buffer (in the first place) applies for an input tax deduction from the turnover tax separately shown by the missing trader in his invoices. The buffer behaves unobtrusively from a tax point of view. This is because it sells goods as the last link in the chain to other buffers or to the distributor. Input tax and sales tax are therefore roughly in balance.

Due to the sale of the goods to other European countries, the distributor declares a tax-free intra-Community delivery for which no sales tax is incurred. The distributor applies for input tax deduction from the buffer invoice. This results in a so-called input tax overhang, which is reimbursed by the tax authorities.

3. Where does the Turnover Tax get lost?

In the carousel shown, the missing trader receives the profit at the end. This is because he receives the sales tax from the buffer (first in the chain), but does not pay it himself to the responsible tax authority.

The buffer, on the other hand, does not suffer a loss as it receives the sales tax paid to the missing trader back from the distributor, usually with a small surcharge on the price of the goods. The distributor also has no damage, as he receives the sales tax he has to pay back from the tax office.

The sales tax damage, which results from the fact that the missing trader has received input tax back without receiving sales tax himself, ultimately remains with the tax office.

4. Articles with high Mobility

Typically, VAT carousels occur when trading in items that are easy to transport, internationally traded and of high value. These are mostly electrical goods. In the past, however, there were also VAT carousels, for example when trading in CO2 certificates. Due to the high sales prices and the high mobility, sales and thus the “profits” from VAT fraud increase.

5. Intent of Criminal Tax Evasion?

The most important defence strategy in criminal tax proceedings concerns the question of which of the persons involved really knew which system they were involved in. Generally speaking, the further away a link in the chain is from the missing trader, the less likely he is to have an overview of the whole situation. He therefore acts without intent in the criminal sense. Those people who come up with a VAT carousel make sure that also bona fide companies are included in the chain. This makes it particularly difficult for the tax authorities to expose the system as such.

6. VAT Backgrounds

The VAT treatment of the respective sales transactions is dependent on several legal terms of VAT law.

1. Entrepreneur

An entrepreneur in the sense of value added tax law is someone who carries out a commercial or professional activity independently. It depends crucially on the durable attainment of incomes.

In the case of a missing trader, the entrepreneurial status is questionable from a tax point of view. Because these exist usually only on paper. In many constellations, they are also unable to dispose of the goods they have shown on the invoices at all or do not deliver them themselves. Also the economic risk is missing with the Missing Trader typically, at least if he does not use capital to acquire goods.

(6. VAT Backgrounds)

2. Tax Debtor

While the right to deduct input tax is often disputed, the tax courts are in any case in agreement that missing traders owe VAT to the tax office even if they have not provided the service stated therein. Background is § 14c UStG, according to which everyone who issues an invoice with value added tax must also pay it.

14c UStG is an absolute law. It is therefore irrelevant whether the state has actually suffered a loss due to turnover tax. Value added tax is owed even if there is only a risk that an invoice recipient will claim input tax on the basis of an unjustifiably issued invoice. This is to prevent abuses.

According to the jurisdiction of the Federal Court of Justice in criminal tax cases, the evasion of turnover tax resulting from an invoice according to § 14c UStG can also be the basis of a conviction for criminal tax evasion.

(6. VAT-Backgrounds)

3. Input-Tax

Although the sales tax is owed by the missing trader, he is usually not entitled to deduct input tax. According to the jurisdiction, this applies even if a delivery was actually made to the invoice recipient but the underlying service relationship was concealed. In these cases the formal requirements for the deduction of input tax defined in §§ 15 or 14 and 14a UStG are missing.  Accordingly, input tax can only be deducted if the issuer of the invoice and the supplying entrepreneur are identical.

It is also frequently disputed whether there is a case of abuse of the VAT system. In case of doubt, such an abuse would be affirmed if Missing Trader and Buffer agree that invoices are only issued on paper.

However, the Federal Fiscal Court (BFH) decided on 21 June 2018 (Ref. V R 25/15) that the right to deduct input tax does not necessarily presuppose that the economic activities of the supplier are carried out at the address stated in the invoice. The decisive factor for the right to deduct input tax is that the entrepreneur can actually be contacted at the address stated in the invoice. A so-called letterbox address is also sufficient for this purpose.

(6. VAT-Backgrounds)

4. Tax Evasion and Participation in it

Whoever owes taxes according to the principles described above as an entrepreneur or via the formal provision of § 14c UStG, but does not register and pay them with the tax office, is liable to prosecution for tax evasion. According to German law, however, the prerequisite for criminal liability is that the tax debt has not been reported to the tax office. If these are duly reported but still not paid, then only an administrative offence according to § 26b UStG (damage of the turnover tax revenue) exists.

In addition to the question of who of the parties involved acted intentionally and who was in good faith, criminal law often also includes the question of who is to be regarded as the main offender and who can only be prosecuted for aiding and abetting. This question also arises in particular for tax advisors who are integrated into the system and who, from a purely external point of view, only do what they do for other clients – i.e. submit tax returns or apply for tax refunds to the tax office.

(6. VAT-Backgrounds)

5. Side-Effects of a Conviction for Tax Evasion

Accused persons convicted of participating in a VAT carousel are often severely punished. In addition to the criminal consequences, they are also threatened with tax liability, which can destroy their economic existence. In this context it plays a role that the German insolvency law regularly denies the residual debt exemption to the person convicted for tax evasion. This means that those affected may have debts in the millions until the end of their lives.

For tax consultants who are suspected of having participated in a sales tax carousel, there is also a threat of professional consequences, which can even lead to the withdrawal of the licence as a tax consultant. If a criminal liability is affirmed by tax consultants, a professional court procedure is regularly initiated.

7. Other Constellations: Straw Men and Cover Bills

Unlike the cases where missing traders were used, it sometimes happens that a “straw man” is used by a backer. This person appears to the outside world as if he himself is an entrepreneur and makes responsible decisions. In his name the invoices with the value added tax are also issued. In fact, however, all decisions are made by a third party who only acts from the background. As a rule, the latter also procures the goods that the straw man continues to supply. The third party – i.e. the person behind the goods who is actually economically responsible – also collects the money from the sale of the goods. In Strohmann constellations, income and trade tax is regularly evaded in addition to sales tax.

Strohmann people often appear in the area of scrap metal or waste recycling companies. It is typical for these industries that the origin of the delivered goods cannot be clarified beyond doubt. Sometimes the straw men are exchanged also in short temporal distances, which makes it more difficult for the tax authorities to determine the true economic wire puller.

Another constellation that frequently occurs in practice is the so-called cover invoice. A company acquires goods without the actual supplier appearing. In order to have no disadvantages with the tax, the achievement receiver procures so-called cover calculations of another person. These are typically persons “who have nothing to lose”. They write the invoices in their own name without actually having carried out a delivery or service themselves. The aim of such cover invoices in tax audits is not to attract attention or to cover up other tax reductions.

8. Defence Strategies

Every VAT carousel is different. Accordingly, every case has to be assessed anew. In particular, it must always be carefully examined whether there is actually a punishable tax evasion. In particular, it must be checked separately for each individual link in the chain whether tax evasion is actually a punishable offence. The possibilities for defence strategies are as varied as the cases themselves.

Addendum: Since January 2019, new problems have arisen for online traders. Ebay, for example, is asking them to submit certificates in accordance with § 22f UStG. If this does not happen, the merchants concerned are threatened with criminal proceedings on suspicion of VAT evasion.