Thank you for your letter of 5 June 2007 to Baroness Cohen of Pimlico[3], (not published) regarding the Committee's recent report on Missing Trader Fraud in the EU. The letter was considered by Members of Sub-Committee A at their meeting on 12 June and Baroness Cohen has asked me to reply to you. Baroness Cohen and the Sub-Committee were extremely interested in the briefing annexed to your letter and look forward to the official Government response in due course. The Sub-Committee hope that the official response will show more concern for the interests of honest traders and the cost of the extended verification strategy.

  The Sub-Committee will be pressing for a debate on the report on the floor of the House before the summer break, and would welcome clarification on some issues prior to this debate. First, on page seven of the briefing you state that in over 95% of cases where traders are subject to extended verification HMRC finds a link to MTIC fraud, or there is sufficient suspicion that HMRC has a duty to continue to investigate. I would be grateful if you could break down that 95% into the two categories and state what percentage of extended verification cases do discover traders participating in or profiting from trading linked to MTIC fraud, and what percentage lead to further investigations.

  The Sub-Committee noted HMRC's policy, outlined on pages 7 and 8 of the briefing, to support firms facing financial hardship because of extended verification. However, the Sub-Committee also noted that HMRC requires a financial guarantee from the trader. before support will be provided. The Sub-Committee would suggest that financial institutions will not provide guarantees for firms facing hardship as, under the Companies Acts, the directors of effected firms would not be able to give guarantees about the viability of their organisation to the financial institutions. We do not feel that this automatically implies that the firms facing hardship are "high risk", but that instead the financial institutions are prudently exercising their discretion and not lending to firms that are not able to truthfully predict future cash flow.

  The Sub-Committee would also be interested in any details you are able to provide regarding the level of the fraud recorded in 2006/07 financial year. The Sub-Committee appreciates that this calculation takes some time and is normally published alongside the PBR in the autumn, but if there is any possibility of providing a figure for the first half of the year, or an estimate which is not based on levels of trade in the affected sectors, then the Committee would be grateful.

13 June 2007

  I would like to take the opportunity to respond to the points you raised in your letter of 13 June 2007 to John Healey, Financial Secretary, following his recent letter to Baroness Cohen on Missing Trader Fraud.

  You asked about the effect of the verification strategy on honest traders. HMRC knows that most people and businesses want to pay the right tax at the right time and are therefore committed to making this as easy as possible. Customer focus is a core HMRC value and HMRC constantly seeks to achieve the right balance between customer requirements and compliance.

  However, HMRC will deal firmly with anyone who intentionally avoids their responsibilities. Government and HMRC have a duty to protect the revenue. The response to VAT Missing Trader Fraud has been, in my view, proportionate, targeted and risk-based. The courts, to date have supported HMRC's policy and practice.

  The strategy for tackling MTIC fraud is risk-and-intelligence based and HMRC's interventions to verify repayment claims are targeted at specific activity indicative of trading in supply chains tainted by VAT fraud. There was a dramatic escalation of activity by companies trading in goods traditionally associated with MTIC in the first part of 2006 for which HMRC was unable to identify any legitimate commercial reason. This was accompanied with dramatic increases in the value of VAT being reclaimed by these companies. HMRC and I consider it proportionate, given the huge sums of public money involved, that those involved in such a large and unexplained growth in trading should have their large repayment claims investigated before payment.

  Given the contrived and highly-orchestrated nature of the supply chains, it is inconceivable that any business can be unaware of MTIC fraud, or not suspicious of the trading patterns and practices encountered. Although the repayment claims have been pre-selected on risk criteria, verifications are not commenced with any pre-determined outcome in mind, and the aim from the beginning is to establish the facts and the true nature of the relevant transactions as soon as possible. It is only when this has been established that HMRC can then determine the validity of the claim. Of 95% of the traders whose repayments have been selected for verification, HMRC have to date found firm evidence of fraud in 34% of cases by value. Of the remaining 66% they have identified strong indicators of links to MTIC fraud, requiring them to undertake further investigation to determine the veracity of these claims.

  If at any time it becomes clear that the transactions HMRC are verifying do not form part of an overall scheme to defraud—for example, when a claimant has purchased goods direct from a manufacturer for wholesale distribution to the retail market—then arrangements are made to release any monies withheld. Similarly, HMRC pay input tax claimed in respect of legitimate business overheads such as accountancy costs or freight forwarder charges, once satisfied of their veracity.

  The introduction of the reverse charge on 1 June 2007 will remove immediately the threat of fraud in the goods to which it applies, enabling honest genuine traders in those goods to continue trading free of the risks of MTIC fraud in their industry.

FINANCIAL GUARANTEES

  You also commented on the provision of financial securities to businesses facing hardship. I note the point you make here, but to date HMRC have found that questions and comments about financial security from traders under verification have not focused on the fact that they are unable to convince banks about the long-term viability of their businesses.

FRAUD LEVELS

  As you have stated, our practice is to publish fraud estimates alongside the PBR and we are unable to provide an interim figure. However, HMRC has updated the trade statistical data that was previously provided to the Committee and the table is below:

  You will be aware that, in May this year, the House of Lords EU Select Committee published a report Stopping the Carousel: Missing Trader Fraud in the EU. [4]While taking evidence for the Report, Sub-Committee A heard from the Paymaster General. In the evidence session on 6 February, the Minister told the Sub-Committee that

"our [i.e. HMRC's] current administrative arrangements are having a downward pressure to the point where it [i.e. MTIC fraud in the VAT system] is now miniscule." (Q229, p53)

  and, when asked whether the extent of the Missing Trader Fraud through existing mechanisms is likely to decline,

"the indications from the trade figures, ONS figures, indicate there has been an absolutely massive drop." (Q231, p54)

  This second statement was noted by the Committee in the report, and quoted at paragraph 28.

  The Sub-Committee were therefore surprised to read in the Pre-Budget Report and Comprehensive Spending Review that there were still considerable levels of MTIC fraud in 2006/07. Paragraph 5.104 of the Pre-Budget Report and Comprehensive Spending Review notes that levels of attempted fraud in 2006/07 were £2.25-£3.25 billion. While the Sub-Committee are pleased to note that this is considerably lower than the level of attempted fraud in 2005/06, it remains higher than the estimated figures for every other year this decade. The Sub-Committee would therefore be grateful if you could clarify these figures. Are these figures an indication that the fraud has mutated to other sectors?

  You will also be aware that one of the issues raised by the Report was the impact of extended verification upon small businesses operating in the affected sectors. The Sub-Committee continues to receive representations from industry about the impact of extended verification. The Sub-Committee would therefore be grateful if you could provide an update on whether the number of businesses currently subject to extended verification has risen or fallen since the Report's publication in May this year.

  As is the practice with letters regarding scrutiny items, I feel that I should let you know that the Committee intends to publish this letter and your reply.

23 October 2007

4   20th Report of Session 2006-07, HL Paper 101. Back