VAT carousel fraud: how it works and how to protect yourself

Carousel fraud is the best known and, according to estimates by Europol and the European Public Prosecutor's Office, the most fiscally damaging form of VAT fraud in the European Union — with losses of the order of EUR 50 billion per year at Union level. It takes its name from the fact that the same goods can circulate in a loop through several Member States, with each loop depriving the state of an amount of VAT that will never be paid. But the reason it is worth writing about is not merely its criminological interest: a carousel fraud chain almost always also contains companies that have nothing to do with the fraud — and it is precisely those companies that often end up paying the bill.

Why carousel fraud exists at all

The scheme exploits the fundamental architecture of the European VAT system following the abolition of border controls between Member States in 1993. A supply of goods to another Member State is exempt from VAT, and the tax is accounted for by the acquirer in their own country. This means that goods travel between Member States without VAT having been paid — and it is precisely that moment, in which someone holds goods with the full VAT potential while the tax has not yet been paid, that the fraud exploits.

The mechanics of the scheme, step by step

It is easiest to understand through a simplified example with four participants and goods worth EUR 100,000, with VAT at 25 per cent.

◆Step 1 — the goods enter without VAT actually paid. Company A from another Member State supplies goods to Croatian company B. An intra-EU supply of goods is exempt from VAT; B accounts for Croatian VAT on the acquisition but simultaneously deducts it as input VAT — the effect is zero, so the goods enter Croatia without a single euro of tax actually paid. ◆Step 2 — the missing trader. Company B sells the goods to domestic company C for EUR 100,000 plus EUR 25,000 of VAT and collects the full EUR 125,000. It never pays the VAT charged to the state: after a few months the company disappears — with no assets, no accessible responsible persons, and formally proper invoices left behind. ◆Step 3 — intermediaries blur the trail. Company C, the so-called buffer, resells the goods on at a small margin and duly reports and pays its share of VAT. There may be several such intermediaries in the chain — their role is to lengthen the chain and make it look proper on paper. ◆Step 4 — the broker claims a refund. Company D at the end of the chain supplies the goods back to another Member State, for instance to company A again. That supply is exempt from VAT, so D asks the state for a refund of the input VAT charged to it on acquisition — and the net loss to the budget essentially corresponds to the EUR 25,000 of VAT that B never paid. ◆Step 5 — the carousel spins. The state refunds from the budget a tax that never entered it, the goods are back with company A — and the loop can start again. Each new rotation of the same consignment means fresh damage to the budget.

Carousel frauds typically target goods of high value and low mass, which are easily and quickly resold — and a variant without any goods at all is also possible, in which only invoices circulate. Viewed individually, almost every participant in the chain looks proper: invoices exist, goods move, returns are filed. That is precisely why these schemes are hard to detect, and they are countered only by linking data across the entire chain and by international exchange of information.

Why this matters to legitimate businesses too

The most important message for anyone trading in goods from other Member States: it is possible to enter a carousel chain unknowingly, by buying goods at a favourable price from a supplier who later turns out to be a missing trader. Under the settled case law of the Court of Justice of the European Union, the right to deduct input VAT may be refused to a taxable person who knew or ought to have known that, by their purchase, they were participating in a transaction connected with VAT fraud — and the same rule is contained in Article 127 of the Croatian VAT Act: a taxable person in respect of whom it follows from objective circumstances that they knew or ought to have known that the VAT on the transaction would remain unpaid will be denied the right to input VAT. In practice this means that, in an audit, the tax authority does not have to prove that the business participated in the fraud — it is enough to establish that the circumstances of the transaction were not checked the way a reasonable business would have checked them. The consequence is denial of input VAT on incoming invoices and, in more serious cases, a criminal law dimension as well.

How to protect yourself

In this area the defence is called due diligence on your business partner — and documenting it. There are several signals to watch for:

◆a new supplier offers high-value goods at a price noticeably below the market, with pressure to close the deal quickly ◆the supplier was recently established, with no business history, employees or genuine infrastructure, yet trades in unusually large amounts ◆the partner's VAT identification number does not exist or is not valid in the VIES verification system ◆payments are redirected to the accounts of third parties or to third countries, without a clear business reason ◆the goods do not physically follow the documentation — warehouses, transport and quantities do not match the paperwork

Alongside recognising the signals, it is essential to carry out checks systematically and to keep a record of them: verification of the VAT ID, the court register and the partner's creditworthiness, and documentation of contacts and the terms of the deal. It is precisely that documented diligence that makes the difference between a business whose input VAT is recognised and one whose is denied.

Conclusion

Carousel frauds live on the edges of legitimate supply chains — and for that reason the risk is borne not only by the perpetrators, but also by companies that entered the chain without knowledge of the fraud. If you trade in goods from other Member States, checking your partners is not administrative excess but tax protection: input VAT once denied is hard to recover, and the defence begins with evidence of what you checked before the transaction. For an assessment of the risks in your supply chains, or support in an audit touching on these issues, feel free to get in touch.

This article is based on scientific papers by Croatian authors on carousel fraud and on the case law of the Court of Justice of the EU; it is informational in nature and does not constitute tax advice for any individual case.