New measures to fight VAT fraud on online sales

We talked to two of the DG TAXUD architects behind the new rules and the information sharing system underpinning them about how the new system will work to help Member States recoup much-needed VAT revenues!

Read on to learn more from Costantino Lanza, Deputy Head of the VAT Administrative Cooperation and Legal Issues Unit and Simone Brogi, Team Leader on Indirect Taxation for IT Systems.

What was the reason for introducing the new rules?

Costa: Well, our starting point for any measure in the VAT field is always the sizeable VAT Gap in the EU – that’s the difference between the VAT revenues expected in a given Member State and the VAT actually collected. The overall VAT Gap in the EU still stood at €61 billion in 2021, which although improved on previous years, is clearly still unacceptable when you consider that these revenues could be paying for public services like schools and hospitals.

While the VAT Gap is made up of revenues lost due to many reasons, a high proportion takes place due to VAT fraud, including in online shopping when EU consumers buy from outside the EU and fraudsters mislabel products as low-value goods so that less or even no VAT is paid on these imports.

But because of the way VAT in the EU is organised, cooperation between Member States deals mainly with traditional businesses. Investigations related to VAT fraud start based on the knowledge that the tax administration in a Member State would have about the businesses that are established in their territory and are registered for VAT in that jurisdiction.

With e-commerce, online shops selling into the EU could be established anywhere in the world. So, it’s difficult to identify the origin of online businesses selling goods or services in another Member State. Tax administrations don’t have the information they need to assess whether the correct amount of VAT has been paid or not.

With the new Central Electronic System of Payment Information (CESOP), identifying these online sellers is easier thanks to the sharing and exchange of payment data. The system facilitates the work of the Member States to better detect potential VAT fraud and prevent loss of VAT revenues. And since the data needed for this analysis is already collected and held by payment service providers when they facilitate online sales, there was really no better starting point.

How will the new system work?

Simone: The idea was to change the usual approach and start from the bottom. That means identifying the payment and following the transaction to identify where the money is coming from, to link it to a Member State.

Under the reporting rules, payment service providers such as banks and credit card companies report the payment information to tax authorities if a threshold of 25 cross-border transactions per quarter is reached for online payments to an entity in another Member State or a territory outside the EU. This threshold is an indication of a possible commercial activity. Clear guidance and rules are in place to determine when this threshold is reached or breached and how the reporting should be done.

Tax authorities then transmit the payment information to the CESOP system, which will store, aggregate, and make available the results of the analyses to Member State experts in the Eurofisc networks, who are specialised in VAT fraud. It is then up to the Member States to act when they notice suspicious activity or fraudulent sellers. They can coordinate EU level follow-up actions such as multilevel controls, administrative inquiries, and audits. In 2025, we should see the first fruits of this collaboration.

The reporting obligations will always concern the person or entity who is selling. So, CESOP will keep records on the beneficiary (the payees) but not on the products or services bought.

How was the new system developed?

Simone: The new system was developed over several years of continuous collaboration between the Commission, Member States, Eurofisc and industry.

In 2021, we started defining the parameters of the system to determine what the system should be doing, how it should work, or what other systems should be linked to it. We then started the functional and technical development.

It took around three years to reach this first release, but the work hasn’t finished. Additional features and upgrades will be deployed in the future, so that the system remains up to date and continues to facilitate the work of the anti-fraud experts.

For example, we already connected CESOP with other systems and applications like the one that supports the VAT declaration of cross border transactions. By doing so, so-called red flags or risk alerts can automatically be detected by the system.

We expect around 7 to 8 billion transactions and a few million payees in the system – clearly, it would be impossible to check all those transactions manually without having a smart way to do it. Therefore, by linking the new system with other systems and by crosschecking with additional data, we came up with a solution that eases and automates the identification and detection of possible suspicious behaviour or mismatch. If there is a mismatch, the system will flag the trader and national authorities will decide whether to proceed with further investigation.

The work was complex, but we are very satisfied with the system, and we look forward to seeing how it continues to develop.

What role did the payment service providers play in the development of the new system?

Costa: The payment service providers were involved right from the beginning. We set up an expert group where we worked closely together with them and the Member States to provide industry with clarifications and guidelines on the reporting obligations as well as a list of frequently asked questions, and to identify the technical requirements for the development of CESOP. For this purpose, the Commission also hosted two large online workshops with more than 1500 participants in total.

To learn more about the CESOP system, you can visit the dedicated webpage. A press release is also available online.