Brussels once more rejects Hungarian request for reverse VAT

So far, only one out of three applications from the Hungarian government has been approved by Brussels to introduce reverse charging on value added taxes in certain segments of the agricultural sector. The most recent rejection is for sugar trade, since the European Commission found that allowing the process would actually have far more serious consequences than the good it could do – anti-corruption watchdog and investigative journalism site, atlatszo.hu reported.

Brussels has allowed reverse taxes for wheat, rejected its application to pork and at the end of April, also dismissed an application for sugar, a sector of Hungarian agriculture that is widely considered as a segment that is highly contaminated with illicit practices and tax dodging.

Prior to the April elections, a former official at the state tax and customs authority NAV came to the public claiming to have knowledge and evidence of a widespread practice of VAT fraud in relation to sugar trade, a method that he said causes an annual HUF 1 trillion in damages to the Hungarian state. He also claimed that the illicit practices are done with the knowledge and consent of the authorities.

Various news outlets have conducted tests into the matter and determined that the sugar products with teaser prices that are too good to be true, literally can’t be sold at such price levels unless the taxes were “reduced” at some point in the supply chain. All chains selling the “too cheap” sugar have rejected any notion that they were involved in illicit practices and the former official’s claims have led to no repercussions.

The fraud most common for the standard or “straight” VAT system is as follows: A sells something to B, who sells the same goods to C and deducts the VAT charged by A from the overall sum. I.e.: C only pays the gap between the two VAT sums to the treasury.

Under fully legal conditions, both A and B would make their own respective contributions to the state coffers.

In case of sugar, the logic is this: A doesn’t pay the VAT that B deducts from the total anyway and C can then sell the product to its customers at what is essentially wholesale price. In this setup, A typically becomes the missing trader by going bankrupt or falling off the grid, while C issues indignant press releases rejecting claims of its involvement in the fraud, saying it can’t be expected to fully explore the entire supply chain of all of its vendors. C also threatens legal action against any party claiming it benefitted from A’s fraudulent practices.

Reverse taxation takes away the need for the missing trader trick, since the buyer is paying the VAT.

So why is the European Commission so opposed to allowing reversed VAT payments for sugar? The EC report on the matter states that because of the characteristics of the produce – in this case, sugar – there is a risk that the tax fraud phenomenon will involve a bigger group because more parties have a stake in the matter. In practice, instead of a handful of big wholesale firms, the contagion spreads to lower levels of the chain translating into potentially thousands of retailers that have a vested interest in keeping the process ongoing and the fraud concealed.

Reverse charge refers to new VAT accounting laws whereby the buyer, rather than the seller, is liable to pay the VAT on a sale. It is normally frowned upon in the EU since reverse VAT is typically a crisis-management method. As a pro, it presents a more or less successful means to push back VAT fraud. As a side effect, it raises serious other risks: the VAT fraud relocates to neighboring countries, criminal organizations specializing in fraud switch to a different industry, it upsets the structure of the tax system, it causes certain market participants liquidity issues and so on. These risks are the main reason that the EU doesn’t “like” the method and normally allows it only as a temporary measure, mostly for a two-year period.

In summation: the Hungarian state’s capacity to monitor and collect taxes in the agricultural and food sector has taken a considerable blow. The Hungarian government is sticking to reversed VAT as a method, a tool that has dubious effects, instead of taking adequate structural measures, even though central communication in the past clearly illustrated that the government is aware of the risks of reverse VAT. The Brussels decision effectively puts an end to this questionable approach to handling the situation and is compelling the government to take actual measures, opposed to the Hungarian message of Brussels dealing yet another petty and unjustified blow to the Hungarian cause, a political message that has been all too common in recent years.

Read this article in Hungarian here, posted on 07 May 2014.
Translated by Gergő Rácz.