VAT, carousel fraud, joint and several liability

VAT Carousel Fraud and Fictitious Invoices: Defending Against Tax Authority Involvement

You do not need to have orchestrated a fraud to bear its cost. Since the Kittel ruling (CJEU, case C-439/04) and Mahagében ruling (CJEU, case C-80/11), confirmed by the French State Council, the tax authority may refuse a company's VAT deduction on the grounds that it "knew or ought to have known" that its supplier was participating in a fraudulent circuit, hold it jointly and severally liable for tax evaded by a third party (French Tax Code Article 283(4 bis)), deny the exemption on its intra-Community supplies, and impose a 50 per cent penalty under Article 1737 of the French Tax Code for fictitious or complying invoices. On a trading flow of several million euros, the cumulative effect of these reassessments commonly reaches several million euros in aggregate exposure, even before any potential criminal proceedings. Your defence turns on precisely one thing: the burden of proof, which rests with the tax authority, and the demonstration of your due diligence procedures. Our firm represents executives and companies involved in such cases, from the preliminary assessment to the State Council.

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— En bref
The risk
Refusal of VAT deduction, joint and several liability, denial of intra-Community exemption, 50 per cent penalty, potential criminal exposure
The test
The taxable person "knew or ought to have known" that it was participating in a fraud (CJEU Kittel C-439/04, Mahagében C-80/11)
The burden of proof
It rests with the tax authority: material element (the fraud circuit) and intentional element (your knowledge)
The law
French Tax Code Articles 283(3) and (4 bis), Article 262 ter, Article 272(3), Article 1737, Article 1741
Your defence
Documented reasonable due diligence, good faith, item-by-item contestation of the circumstantial evidence, appeal to the State Council
— 01

The Legitimate Business: A Solvent Target in Carousel Schemes

Carousel fraud rests on a straightforward mechanism: an ephemeral shell company, often called a "hub", purchases goods tax-free in another Member State, resells them in France whilst invoicing VAT, pockets that tax, and disappears without remitting it to the Treasury. The goods circulate thereafter, sometimes multiple times, between the same operators. At each rotation, VAT is deducted or claimed without ever having been paid upstream.

When the circuit is dismantled, the defaulting company is insolvent or in liquidation. The tax authority then turns to the solvent operators in the circuit: the trader who bought from the hub, the supplier who shipped to a foreign destination, the platform or intermediary. This is where your case turns: the European Court of Justice jurisprudence permits the authority to deny you a deduction and hold you jointly and severally liable for the evaded tax if you "knew or ought to have known" you were participating in fraud, language now adopted by the French State Council in settled jurisprudence.

The financial stakes are substantial, because the reassessment heads stack: denied VAT deduction, joint and several liability for tax owed by a third party, denial of intra-Community exemption, surcharges of 40 per cent or 80 per cent, a 50 per cent penalty on the invoices at issue, and, in large-scale cases, referral for tax fraud prosecution or proceedings for VAT fraud. A trading margin that was measured in single-digit percentage points is demanded as the equivalent of several years' profit.

Yet these weapons carry a critical flaw: the burden of proof rests with the tax authority, on each transaction, and the European Court forbids it from demanding of the buyer verifications that amount to tax audit itself. A well-constructed due diligence file reverses the balance of power. Our firm concentrates on a limited number of interventions to ensure direct partner involvement in each case.

— 02

The Five Reassessment Fronts in Carousel Fraud

01

Refusal of the deduction right: "knew or ought to have known"

The central basis of the reassessment, rooted in the Kittel and Mahagében rulings of the European Court of Justice.

  • The taxable person who "knew or ought to have known" that its acquisition implicated it in a VAT fraud operation is denied the deduction right (CJEU, 6 July 2006, Kittel, case C-439/04)
  • The burden of proof lies with the tax authority: it must establish, from objective elements, your actual or presumed knowledge of the fraud (CJEU, 21 June 2012, Mahagében and Dávid, cases C-80/11 and C-142/11)
  • The Court forbids the authority from demanding that the buyer verify his suppliers' fiscal standing as a general matter; heightened verification is required only in the presence of irregularity flags
  • The French State Council has adopted this framework: each transaction is contested item by item, flag by flag, and doubt favours the taxpayer
02

Joint and several liability for tax evaded by a third party

French Tax Code Article 283(4 bis) permits the authority to demand from you the VAT that another operator failed to remit.

  • The taxable recipient of a supply who knew or could not ignore that the VAT on that supply, or on any prior supply of the same goods, would not be remitted is jointly and severally liable for payment of that tax
  • Two cumulative elements the tax authority must establish: the existence of the fraud circuit (material element) and your conscious participation (intentional element)
  • Joint liability covers the tax only: penalties and interest on late payment charged to the primary debtor cannot be demanded from you
  • Joint liability cannot cumulate, in respect of the same goods, with denial of deduction based on Article 272(3) of the French Tax Code: often a decisive battleground
03

Denial of exemption on intra-Community supplies

A supplier shipping within the Union may lose exemption if its customer was merely a shell.

  • Exemption under French Tax Code Article 262 ter is removed if the supplier knew or could not ignore that the presumed recipient had no actual business activity
  • Consequence: French VAT is demanded on sales invoiced tax-free, with no ability to pass it through to a vanished customer, representing a fixed cost of 20 per cent of turnover on those sales
  • European Court jurisprudence protects the supplier that has performed reasonable due diligence on the reality of transport and the recipient's taxable status (Court of Justice, 27 September 2007, Teleos, case C-409/04)
  • Documentary proof of transport (CMR, loading notes, insurance, supply chain traceability) and verification of intra-Community VAT identification numbers form the first line of defence
04

Wrongfully invoiced VAT and the 50 per cent penalty

He who invoices the tax owes it; he who invoices non-existent operations faces a massive penalty.

  • Any person who states VAT on an invoice is liable for it by the mere fact of invoicing (French Tax Code Article 283(3)), even if the transaction was not taxable; rectification is possible only under strict conditions
  • Conversely, wrongfully invoiced VAT is non-deductible by the invoice recipient (French Tax Code Article 272(2))
  • Article 1737(I) of the French Tax Code penalises the issue of invoices corresponding to no real supply or service with a 50 per cent penalty on the invoice amount (fictitious invoices)
  • The same 50 per cent penalty applies to complying invoices (misstatement of supplier or customer identity, using a nominee), calculated on sums paid or received
05

The criminal dimension: from surcharge to prosecution

Carousel cases rank among the first candidates for referral to the public prosecutor.

  • Tax fraud (French Tax Code Article 1741) exposes individuals to imprisonment and substantial fines, aggravated sharply where an organised group or overseas accounts are involved
  • Assessments exceeding EUR 100,000 accompanied by 80 per cent or 100 per cent surcharges are subject to automatic referral to the public prosecutor (French Tax Procedures Code Article L.228); separate prosecutions for VAT fraud may follow
  • The criminal dimension is prepared from the outset of the audit: each response to the authority engages your director's defensive position
  • Our firm coordinates tax defence and criminal defence to prevent one from undermining the other, in liaison with the firm's tax criminal law page
06

Grounds of defence: due diligence, good faith, proof

European jurisprudence charts a demanding but real path to defence.

  • Reconstruct and produce the due diligence file: supplier company extracts and tax clearance certificates, VAT number verification (VIES system), price consistency with market, reality of deliveries
  • Contest the tax authority's circumstantial evidence: abnormally low prices, atypical payment circuits, absence of logistics, corporate linkages; no single flag suffices in isolation
  • Enforce the allocation of the burden of proof: it is for the authority to prove the fraud and your knowledge, transaction by transaction, not for you to prove your innocence
  • Contest each head separately: deduction, joint liability, exemption, and penalty operate under distinct conditions, and the authority's failure on one often defeats the others, up to the State Council if needed
— 03

Our Approach

Our firm intervenes at all stages of carousel fraud cases: preventive audit of supply chains and supplier due diligence frameworks, assistance during audit and response to preliminary assessment, contestation of joint and several liability and Article 1737 penalties, contentious claim and then appeal before the administrative courts, up to the State Council. Where the file includes a criminal dimension, tax defence and the executive's criminal defence are conducted in coordination. The firm's experience in VAT and intra-Community flows permits us to contest the authority's file on its own ground: that of proof.

  • Carousel fraud
  • VAT joint liability
  • French Tax Code Article 283(4 bis)
  • Kittel jurisprudence
  • 50 per cent penalty
— FAQ

VAT Carousel Fraud: Your Questions

Can I be reassessed even though I made no profit from the fraud?

Yes. Since the Kittel ruling by the European Court of Justice (6 July 2006, case C-439/04), a taxable person who "knew or ought to have known" that its acquisition formed part of a VAT fraud is deemed to be participating in that fraud, regardless of personal profit. The deduction right may be denied and joint and several liability under French Tax Code Article 283(4 bis) may be imposed. Your defence consists precisely in demonstrating that you did not know and could not have known: it falls to the tax authority to prove the opposite, by objective elements, transaction by transaction.

What verifications can the tax authority demand of me regarding my suppliers?

The European Court has set clear limits in the Mahagében ruling (21 June 2012, cases C-80/11 and C-142/11): the authority cannot demand as a general matter that you verify your suppliers are meeting their own tax obligations, possess the goods, or are able to deliver them. Conversely, in the presence of irregularity flags (abnormally low prices, recent operator without assets, unusual payment circuits), a prudent operator must make enquiries. In practice, a documented supplier verification system (company extracts, certificates, VAT numbers checked on VIES, price consistency) is your essential protection.

What can joint and several liability under French Tax Code Article 283(4 bis) cost me?

The full VAT evaded by the defaulting operator on the supply at issue, or even on any prior supply of the same goods, which may represent several million euros on an active trading flow. Two crucial limits apply: joint liability covers the tax only, excluding the penalties and interest on late payment of the primary debtor, and it cannot be combined, for the same goods, with denial of deduction under Article 272(3) of the French Tax Code. Verification of these limits and contestation of the intentional element form the first two defence axes.

I invoiced VAT on transactions the authority considers fictitious: what happens?

Two mechanisms combine. First, VAT stated on an invoice is owed to the Treasury by the mere fact of invoicing (French Tax Code Articles 283(3) and 283(4)), even if the transaction never occurred or was not taxable, and the recipient cannot deduct it. Second, the issue of invoices corresponding to no real supply or service exposes you to the 50 per cent penalty on the invoice amount provided by Article 1737(I) of the French Tax Code. For complying invoices (concealment of the true identity of supplier or customer), the same penalty applies, computed on sums paid or received. Your defence concerns the reality of the transactions, the true identity of the invoice issuer, and the intentional element.

Does a carousel case always end up in criminal proceedings?

No, but the risk is real and must be anticipated from the outset of the audit. Assessments exceeding EUR 100,000 accompanied by 80 per cent or 100 per cent surcharges are subject to automatic referral to the public prosecutor (French Tax Procedures Code Article L.228), and carousel cases may result in prosecutions for tax fraud (French Tax Code Article 1741) or even VAT fraud. Conversely, a successful tax defence, which achieves abandonment of fraudulent intent or discharge of assessments, substantially undermines the criminal file. This is why our firm treats each response to the authority as a component of any eventual criminal file and coordinates both defences where prosecutions are pursued.

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