Quantifying the shadow economy
Is combating the shadow economy like firefighting? Prevention, rapid reaction, cooperation and information exchange are the cure
A survey about the shadow economy targeted at the authorities yielded plenty of information on challenges faced in combating it. The answers show that the shadow economy is becoming more international, professional and serious. The authorities call for enhanced cooperation and information exchange. They would like preventative measures and earlier intervention into the shadow economy.
The shadow economy is becoming more international and complex
Of the respondents, 84% were of the opinion that internationalisation has led to weaker opportunities in preventative efforts. Internationalisation is evident in problems related to foreign labour and money transfers via foreign bank accounts, for instance.
The shadow economy is becoming more serious and it is now more difficult to investigate its operations. So say 86% of the respondents. In the view of the authorities, financial crime has become professional, which is evident in, for instance, the use of companies for fraud or fraudulent conveyance. According to the respondents, more organised criminals are now involved in the shadow economy.
Authorities call for greater cooperation
Different authorities wrestle with similar problems and phenomena, but often only examine them from their own perspective. As a solution, they would like to step up cooperation and have a broader mandate to enhance their control efforts. For instance, the respondents would like to have joint investigation teams, engage in greater cooperation in practical operations and share knowhow. Information exchange between government organisations should be facilitated and obstacles to information exchange eliminated.
Preventative operations and early intervention are important
The respondents state that deficiencies in how companies attend to their taxes and other obligations should be public information. If a better overall picture were available of the condition and reliability of a company, this would serve to prevent the shadow economy. Of the respondents, 87% believe that increasing public availability of information on compliance with obligations could reduce the shadow economy.
The authorities are of the opinion that preventative measures against the shadow economy and real-time control are important, as retroactive control gives an advantage to shadow economy operators and financial criminals.
The survey of authorities was drafted by the Grey Economy Information Unit and carried out in March 2019. A total of 620 responses were received from 22 authorities and organisations engaging in statutory control efforts.
VAT refunds under false pretences causes VAT losses of about EUR 30 million in Finland each year. However, refund fraud accounts for less than five per cent of the entire VAT gap, which amounts to about EUR 1.3-1.8 billion.
Fraudsters stand out
VAT refund fraud is committed when a fraudster applies for a VAT refund under false pretences and the Tax Administration pays this unjustified refund.
The Grey Economy Information Unit used special profiling to investigate those applying for VAT refunds under false pretences. Examination of the identified risk group could also be used to estimate the shadow economy VAT gap caused by refund fraud in Finland.
It was estimated that VAT refund under false pretences causes tax losses of about EUR 30 million annually.
Fraud is often committed by professional criminals
Europol estimates that organised crime is behind as much as EUR 60 billion in annual VAT losses in the EU. In Finland, refund fraud is committed by Finnish and foreign actors in the shadow economy – and organised crime has been involved, too.
To prevent crime, the Finnish Tax Administration has enhanced control of VAT refunds in recent years, developed new real-time control mechanisms based on assessment of tax risks, and stepped up co-operation with other authorities both in Finland and internationally, such as with the Estonian Tax and Customs Administration.
Companies ready to take responsibility for combating the shadow econ-omy – more information, incentives and tools are needed
According to a survey conducted with companies, they consider the shadow economy to have a neg-ative impact on fair conditions of competition between companies. According to the respondents, becoming involved in the shadow economy is, as a rule, a conscious act; with the goal to achieve competitive advantage and obtain economic benefit.
The internationalisation of the shadow economy and fraud crime threaten the ability of companies to act correctly
The most important factors preventing companies from acting correctly are a foreign workforce, in-ternationalisation of the shadow economy, and the exploitation of companies in fraud crime. The companies responding to the survey also felt that organised crime is a threat to acting correctly.
According to them, the most common manifestations of the shadow economy are sales without receipt and phenomena related to the use of an undeclared workforce. In their work, the officials of employee organisations have most often encountered inadequate pay, violation of the terms of employment, and neglect with regard to employer contributions.
The volume of the shadow economy has remained unchanged
According to most of the companies, the volume of the shadow economy has remained unchanged during the past three years, though there were sector-specific differences between the responses. Slightly over half of the companies in construction were of the view that the shadow economy has decreased slightly or considerably, whereas more than 80% of the transportation companies were of the opinion that shadow economy has either increased or remained unchanged during the past three years. Unlike other sectors, most of the companies in the transportation sector felt that international-isation has increased the shadow economy during the past three years.
Companies to adopt a more prominent role in combating the shadow economy
Companies are willing to take more responsibility and a bigger role in combating the shadow econ-omy. According to the survey, more than 60% of the companies consider that the responsibility to combat the shadow economy belongs to companies rather than the authorities. However, the respond-ents considered active co-operation between companies and the authorities as an effective way to combat the shadow economy. The companies were also of the opinion that other effective means are tax incentives, control and audits, as well as supporting correct action. They felt that the general atmosphere and attitudes can be positively affected by acting correctly.
Better services are desired for the assessment of companies’ financial reliability
According to the respondents, companies are well-positioned to identify and find reliable partners. However, they would appreciate new, even better tools for combating the shadow economy. In par-ticular, better services should be available for recognising and assessing the reliability of partners. According to the respondents, the better availability and broader publicity of information on the ob-ligation compliance of companies would promote measures to combat the shadow economy.
Intra-Community trade fraud leads to major tax gap in Finland too
VAT losses due to intra-Community trade fraud amount to at least tens of millions of euros a year in Finland.
Fraudsters abscond once they have reaped the tax benefits
According to the European Commission, tax fraud in intra-Community trade causes VAT losses of as much as EUR 50 billion annually. VAT fraud cases in intra-Community trade are complex and such schemes often involve numerous actors in different countries. One of the key roles is that of the fraudulent intra-Community purchaser – referred to as a “missing trader.”
Missing traders are often fictitious companies that do not engage in actual business operations. During a four-year monitoring period, at least 100 intra-Community purchasers were active in Finland that had indications of intentional neglect of VAT.
Such missing traders caused a tax gap of about EUR 12-15 million per year. When other fraudulent actors connected to these missing traders are counted, the tax gap can rise to as much as EUR 35 million per year.
Fraudsters stand out
Special profiling was used to identify companies that probably engage in fraudulent intra-Community trade. Examination of the identified fraudulent companies could also be used to estimate the shadow economy VAT gap caused by intra-Community trade in Finland.
The missing traders identified during profiling were primarily limited companies. They most commonly engaged in wholesale, retail and construction. Such companies were often subject to assessment by estimation, and it was common for them to have tax debts. These companies paid scant taxes to the Tax Administration.
Missing traders comprise clusters of companies in the shadow economy – further research is needed
In terms of their operations, the missing traders identified during profiling were exceptionally strongly grouped in clusters of several companies. In addition, it was far more common than usual for these companies and their responsible officers to be connected to companies entered in the Estonian Trade Register. The largest cluster of companies in the target group comprised a total of 99 companies, 62 of which were Estonian.
Profiling and estimates were based on fraudulent actors found in tax audits. As few shadow economy cases had been analysed, statistically speaking, the analysis could only cover one role in intra-Community fraud: missing traders. Assessing the total tax gap caused by intra-Community fraud in Finland would require a more detailed analysis of other roles.
This article is based on a report by the Grey Economy Information Unit 1/2018
Companies identify the grey economy less frequently than before
In the autumn of 2017, the Tax Administration surveyed Finnish companies and entities’ views and attitudes towards taxes and the Tax Administration. Among other things, respondents were asked about the ways in which the values and strategy of the Tax Administration are visible to customers.
Of the strategic objectives, “it is worth for taxpayers to meet their obligations in full” was considered the objective with the most potential to be realised. No less than nine out of ten respondents felt this way. Only a small percentage of the respondents took the opposite view. At the same time, three out of four respondents were of the opinion that there are “minimal opportunities for error”. Nearly a fifth of respondents nevertheless felt that this had not been achieved.
An interesting detail revealed by the results was that the number of customers who agreed with the claim “I know or know of a company that has bought or sold goods or services undeclared, without receipts” had halved in the course of four years. In 2015, nearly a third of the respondents knew or knew of a company that has bought or sold goods or services undeclared, without receipts. This time around, 17 per cent of respondents agreed with the claim.
“Given that the percentage has declined systematically during the past two surveys, it is fairly safe to say that the trend is indeed declining,” says Janne Myyry, the Tax Administration’s research expert.
Customers also think that the Tax Administration’s values are realised well in its activities. Four out of five customers were of the opinion that the Tax Administration trusts its customers and operates in a way that allows customers to trust the operations of the Tax Administration.
The survey was conducted in the autumn of 2017 in the form of phone interviews to companies of various sizes, chosen through random selection. The survey has been conducted every two years.
Legal changes in the construction sector increased national tax revenue
Legislation changes made in the construction sector since 2011 – such as the VAT reverse charge, the Public Register of Tax Numbers, and contract and employee reporting – increased the payroll in the construction sector in 2015 by around €300 million in total. National tax revenue grew by €100 million in the same year.
Further, reporting of contract and employee details in the construction sector increased the tax revenue by €31 million. The increase was attributable to both employer’s contributions and VAT.
Foreign labour now better accounted for
With the extended duty to report on foreign employees, the number of foreign labour reported to the Tax Adminstration has increased. Wages paid to foreign employees now fall within the scope of taxation better than before.
The Tax Administration’s Grey Economy Information Unit studied how the legislation relating to the requirement of reporting on contract and employee details has affected the construction sector.
Estimate: More than half of the tax gap is attributable to intentional neglect
In Great Britain, conscious and intentional neglect is estimated to account for around 54 percent of the total tax gap. The remaining 46 percent are estimated to consist of errors and negligence, insolvency and disputes about the interpretation of law.
The tax gap means the difference between the theoretical tax receivable and the actual tax revenue. The size of the tax gap shows to what extent the tax payment obligations are met.
The Grey Economy Information Unit has published a Finnish translation of Great Britain’s tax gap report Measuring tax gaps 2014. One aspect analysed in the report is the division of the tax gap based on taxpayer behaviour.
The reverse charge mechanism in the construction industry increased VAT revenue by at least €75 million a year
The VAT reverse charge in the construction industry entered into force on 1 April 2011. The reverse charge mechanism means that the main contractor in a construction contract chain pays the Finnish Tax Administration the value added tax on all the construction services included in the contract.
On account of the amended legislation, the portion of VAT payable by main contractors has increaed significantly and the portion payable by subcontractors in the lowest level has decreased correspondingly.
The Grey Economy Information Unit has calculated the impact of the VAT reverse charge on VAT revenue in the “F Construction” sector. The calculation was based on analysing the transaction data of the tax account and the data in periodic tax returns submitted to the Tax Administration. The data before and after the tax reform were compared.
The reverse charge mechanism in the scrap industry would increase tax revenue by around €7–8 million a year
Tax audits performed in the scrap industry have revealed concealed sales, unjust VAT deductions and failures to report and pay taxes. Other shadow economy phenomena detected include straw men and the use of fake sales receipts.
The scrap trade report surveys the shadow economy activities detected in tax audits in the scrap industry, and particularly their effect on VAT revenue.
The report also discusses the application of the VAT reverse charge to scrap trade in Finland – how many companies would fall within the scope of the reverse charge and how big a benefit could be achieved by amending the legislation.