VAT and GST fraud: the tax small firms feel most, and how it gets stolen at scale

Corporation tax only touches your profit. VAT touches every invoice you raise. You collect it, you carry it, you hand it over each quarter whether you made money or not, and the compliance falls on you, not on your accountant's automated systems. So when VAT is gamed, it is not an abstraction in an offshore structure. It is the tax that decides whether your price beats the seller next to you. This page is about how that tax is stolen, and how the rules let a foreign competitor undercut you by exactly the percentage you were legally forced to charge.

This is the one corner of the system where ordinary people break the law on a grand scale, and where, separately, the rules themselves handed an unfair edge to overseas sellers for the better part of twenty years. We treat the two parts honestly. The first is crime. The second was lawful, and arguably worse, because nobody could be prosecuted for it.

Carousel fraud: stealing the tax instead of remitting it

The most damaging form of cross-border VAT fraud in the world is called Missing Trader Intra-Community fraud, or carousel fraud. It exploits a structural feature of the European VAT system, and formerly the UK's: goods crossing a border between member states are zero-rated for VAT, but a sale inside a country carries full VAT. The gap between those two facts is the entire fraud.

It works in stages:

• A trader, the "missing trader," imports goods VAT-free from a supplier in another member state.
• It sells the goods on domestically and charges the buyer VAT, usually 20%.
• Instead of handing that VAT to the tax authority, the trader vanishes, pocketing the tax.
• The goods pass through a chain of "buffer" companies and are eventually re-exported, which creates an apparent right to reclaim VAT.
• The same goods can circle back and the carousel turns again.

The goods of choice are small, high-value and easy to invoice fictitiously: mobile phones, computer chips, gold, and at one point carbon emissions certificates. Under the European courts' "Kittel principle" (the Court of Justice, case C-439/04, 2006), any business in the chain that "knew or should have known" it was part of a fraud can be denied its input VAT deduction. That is the sting in the tail for honest firms: an innocent intermediary that failed to spot the warning signs can be left carrying the loss.

The scale. A European Parliament research estimate puts the average cost of carousel and related cross-border VAT fraud at around EUR 50 billion a year across the EU, with credible estimates ranging from about EUR 20 billion to over EUR 100 billion depending on method. In the UK at its peak, HMRC estimated the fraud cost the Exchequer between £2 billion and £3 billion in the single year 2005-06. The UK largely shut its own carousels down through a "reverse charge" mechanism on high-risk goods, which moves the VAT accounting to the buyer so there is no tax sitting in the seller's hands to steal, and after Brexit the intra-EU zero-rating route into Great Britain closed. The schemes adapt; they do not vanish.

Fake invoices: the same idea, a different name

India runs the same logic under a different label. Its dominant GST fraud is the fake Input Tax Credit: a network creates fictitious invoices for sales that never happened, then claims credit or refunds for GST that was never paid in the first place. The Directorate General of GST Intelligence detected ₹2.01 lakh crore (about US$24 billion) of GST evasion in the 2024 financial year alone, nearly double the year before, across 6,084 cases. Of that, non-payment of tax made up roughly 46% of cases and fake or wrongful Input Tax Credit claims roughly 39% combined. Over five years, Indian authorities detected about ₹7 trillion across 91,000 cases, of which ₹1.78 trillion came specifically from fake input credits. It is carousel fraud's twin: invent the paperwork, harvest the refund.

The e-commerce VAT gap: the bit that was legal, and felt the most unfair

Here is the part that should make a small online seller angriest, precisely because nobody broke the law. For years the rules themselves built in a handicap.

The UK exempted imported goods worth £15 or less from import VAT entirely. The EU did the same below EUR 22, under what was called Low Value Consignment Relief. The effect was direct and brutal for domestic sellers:

• An overseas seller, overwhelmingly on Chinese marketplaces, could ship a low-value item straight to a UK or EU consumer with no VAT collected at all.
• A UK-registered small business selling the identical item was legally required to add 20% VAT.
• Same product, same customer, a 20% price gap, built into the law, against the compliant local firm.

And it was routinely made worse by under-declaring the value of consignments to stay under the threshold. A small domestic seller, doing everything right, was structurally undercut by the exact tax it was obliged to charge. That is not avoidance by a giant with a clever structure. It is the rules disadvantaging the small operator by design.

The reforms, and whether they held. Both systems were overhauled:

• The UK (1 January 2021) abolished the £15 exemption. For consignments worth £135 or less, the seller charges VAT at checkout, or, where the sale runs through an online marketplace, the marketplace becomes the "deemed supplier" and is liable. Marketplaces that keep hosting non-compliant overseas sellers after HMRC tells them become jointly liable for the unpaid VAT.
• The EU (1 July 2021) abolished the EUR 22 relief, created a single "One Stop Shop" return covering all EU consumer sales, and made marketplaces the deemed supplier for non-EU sellers.

It worked, for a while. The EU's VAT gap, the difference between VAT owed and VAT collected, fell from about EUR 99 billion in 2020 to about EUR 61 billion in 2021, an "unprecedented" drop of roughly EUR 39 billion, partly credited to the e-commerce package. Then it reversed. By 2023 the EU VAT compliance gap was back up to EUR 128 billion, about 9.5% of total VAT liability. In the UK, the VAT gap was £8.9 billion (5.0%) for 2023-24, and HMRC's second estimate for 2024-25 put it higher again, at £11.9 billion (6.5%). The reform gains are not holding, which tells you the burden of policing now rests on marketplaces voluntarily policing their own sellers, and the smaller or less scrupulous platforms remain open doors.

The American version: the Wayfair line

The United States has no national VAT. It has state sales taxes, and its unfairness ran the other way until recently. Before the Supreme Court's decision in South Dakota v. Wayfair (2018), a seller with no physical presence in a state owed no sales tax there, under a 1992 rule from Quill Corp. v. North Dakota. That was a structural gift to online sellers and a structural loss for the shop on the high street. Wayfair struck the physical-presence rule down. Every state with a sales tax now applies "economic nexus," and the common trigger is US$100,000 of annual sales or 200 transactions in a state, though the detail varies and a growing number of states have dropped the 200-transaction test. Missouri was the last state to adopt it, effective 1 January 2023, and uses the $100,000 threshold without the transaction count. The fairness was restored at a real cost: a US small business selling into 45 states can now face 45 separate filing regimes.

Why this is the small firm's tax

Run through all of it and the pattern is the same. The compliance burden of VAT and GST falls hardest on the smallest businesses, because a multinational has a dedicated indirect-tax team and pricing power to absorb the cost, and a sole trader has an accountant and a cash-flow problem. The fraud, the threshold games and the nexus complexity all land on the operator least able to carry them. The giant's clever corporation-tax structure is the famous story. This is the quiet one that decides your price.