Examples of frauds in law VAT
For some years now, conflicts in the application of the rule (commonly known as “fraud in law”) may be subject to sanction, but only when they have been made public.
The human capacity to find solutions for life is unimaginable. In the world of taxation, too. Every entrepreneur looks for ways to pay less tax, but beware that the tax authorities may say no.
In reality, the tax authorities have it relatively easy: any tax engineering measure that is not regulated by law or that is not customary or customary, they deny it and call it tax evasion.
See in this blog some cases of VAT fraud.
What is fraud in law?
They are anomalous legal transactions
There are 2 types
Anomalous legal transactions are considered to be those in which a transaction (legal business) is carried out in an artificial way with the purpose of obtaining a tax saving.
In this sense, there are two types of anomalies: simulation and fraud. See what they consist of:
- Simulation: In simulation, the aim is to mask the operation (legal business) that is really intended to be carried out: the parties agree to pretend a business that they never wanted to carry out (absolute simulation), or with the purpose of covering up a business other than the one intended (relative simulation).
An example of simulation would be that of a purchase and sale in which the agreed price is not paid in order to avoid taxation on the donation (real business).
- Fraud in law: In fraud in law there is no concealment, as the artifice is obvious. Although the transaction is lawful and desired by the parties, it is characterised by the fact that it is contrived or inappropriate for the intended purpose and does not produce other relevant economic effects beyond the tax saving itself.
There would be fraud in law, for example, if a company is set up to divert part of the income to it in order not to exceed the limits for exclusion from the module system.
In this case there is no deception or concealment, since a lawful figure – the incorporation of a company – is used, even if this is done with the aim of avoiding a tax consequence.
Fraudulent tax regulation law
Penalties for fraudulent evasion of the law
In both cases, the tax authorities can regularise taxation according to the reality of the underlying legal transaction.
However, the penalty regime is not always the same:
- Simulation . In the case of simulation, given that there is concealment through non-existent transactions, the penalty is automatic. Moreover, the existence of a reasonable interpretation of the rule cannot be invoked against this sanction.
- Fraud in law . On the other hand, if there is a conflict in the application of the tax law, the Inland Revenue cannot impose penalties, except in cases that have been published by the AEAT on its website.
Publication by the AEAT
The process of publication of cases of tax fraud by the AEAT is as follows:
- Each time such a case arises, the tax authorities must set up an advisory committee to issue a report on the matter.
- On a quarterly basis, the tax authorities must make these reports public on their website, which entitles them to impose penalties.
Temporary effect
The tax authorities can only penalise transactions that are substantially identical to the published cases of fraud and for which the deadline for filing a tax return or self-assessment begins after the publication of the report.
Therefore, returns or self-assessments filed earlier are not affected. If you or your company is considering carrying out a transaction that could be considered tax fraud, avoid penalties by first ensuring that it does not correspond to any of the cases already published.
See below some of the most notable cases of VAT fraud…
Published examples of fraud in law
Tourist leasing
Rental of dwellings
The first scenario concerns a parent company and a subsidiary engaged in the rental of tourist accommodation [Advisory Committee Report, No 5] :
- The parent company buys the properties with VAT – because they are new or because it has waived the exemption – and rents them to the subsidiary with VAT (as the lessee is a legal entity, the exemption for the rental of dwellings does not apply). This allows the parent company to deduct the input VAT on the investment.
- The subsidiary subleases the dwellings for tourist use without supplying hotel services – and therefore without VAT. Therefore, the subsidiary cannot deduct the VAT charged by the parent company on the rentals.
- The rental prices charged by the subsidiary to the tourists are much higher than the rentals charged by the subsidiary to the parent company (between 189% and 857% higher).
Thus, since the VAT borne by the parent company on the purchase of the properties is much higher than the VAT borne by the subsidiary on the rentals, significant tax savings can be made.
Tax savings only
The tax authorities consider that in cases such as this one, the requirements for classifying the operation as fraud by law are met, since it is an artificial structure that creates a dissociation between the ownership and the rental of the properties and that does not generate any relevant economic effect, except for the tax saving of deducting VAT.
According to the Treasury, the correct way to operate in these cases would be for the entity that owns the properties to rent them out to private individuals.
Rent to buy
Fraud in law : Luxury villa
Finally, another notable case of legal fraud that has been published involves a company that acquires a plot of land and promotes the construction of a luxury villa on it.
After building it, the company leases it to one of its shareholders with an 11-year purchase option, so that the property becomes the shareholder’s habitual residence.
Since the lease with an option to purchase is subject to VAT (the lease exemption does not apply), the company can deduct the input VAT.
In this case, moreover, the property is not offered to third parties for lease, but is built according to the suggestions and needs of the shareholder (it is built with the sole idea that the property will be used by him) and rented to him at a price below the market price.
Fraud
In a case such as this, the tax authorities also consider that there is fraud: instead of the partner promoting the construction of the property for his own use, this task is carried out by a company – in which the partner participates – with the sole purpose of being able to deduct the input VAT.
Moreover, the existence of fraud is reinforced by the fact that the lease with option to buy – and therefore with VAT – is for 11 years.
In this way, the regularisation regime for investment goods (which ends after 10 years from the start of the rental) does not apply.
If the company were to start renting out the property without VAT before the end of this period, it would have to refund part of the VAT initially deducted.
Fraud in law: Educational activity
Deduction of VAT on works
Another case that has been declared fraudulent involves two companies (subsidiary 1 and subsidiary 2) owned by two foundations. The operation of this case is as follows [Advisory Committee Report, no. 6] :
- Subsidiary 1 (a public school) carries out exempt educational activities – and therefore has no right to deduct VAT – by using a building owned by subsidiary 2, whose only activity is to lease it to subsidiary 1. This lease gives subsidiary 2 the right to deduct input VAT, so it deducts the VAT on the costs of maintaining the building and on a costly refurbishment of the school.
- The rental price is well below the market price. As a result, subsidiary 2 always makes a loss (the rental income only covers 19% of the costs).
In addition, subsidiary 2 finances the investments with capital increases received from the foundations that control it, which in turn come from donations from the parents of the pupils.
Subsidiary 2 has no staff or structure and partly uses staff from subsidiary 1 (school).
No economic motive
The tax authorities consider this to be a case of fraud by law, since the interposition of subsidiary 2 (the company that rents) does not generate any relevant economic effect, except for the tax saving derived from deducting the VAT on the work on the building (school).
