Consumers should beware firms that illegally charge VAT and then pocket the cash meant for the taxman.

Some companies use a false VAT registration number to dupe customers into thinking part of their payment is given to the Government as tax when it is actually used to maximise profits (see the High Street Haggling guide).

As a result, many pay over-inflated prices for goods and services, with the problem compounded by the VAT rate rise from 17.5% to 20% earlier this month.

Consumers can fight back by checking whether a company is legitimately charging the tax and reporting offenders.

MPs are calling for perpetrators to face jail. The current, maximum penalty is double the tax owed, plus interest.

Reports state the problem is most visible in the building trade.

How the scam works

Some fraudsters falsely state part of the price charged goes to the taxman in VAT when, in fact, they simply take extra revenue.

There are two main types of VAT fraud of this nature.

  • Firms that don't have to pay VAT. Companies with annual turnover below £70,000 are exempt so don't have to pay the sales tax. But some claim they do pay it by using a fake registration number and hike prices accordingly without paying the extra to the taxman.

  • Firms that must pay but pocket the cash. Most companies with a higher turnover should register for VAT but some then illegally de-register yet still charge the extra, using their original number for legitimacy, and pocket it themselves. Others don't register in the first place and illegally take additional cash.

If a company falsely charges VAT, whether deliberately or in error, it must pay it to the Government.

If it fail to, it can be fined the value of the full VAT due, plus interest. It must also pay the VAT back.

Those that register late can also be fined up to 15% of the VAT due.

Ian Liddell-Grainger, chairman of the All-Party Parliamentary Taxation Group, described the scam as "blatant fraud" and, in an interview with BBC Radio 4's Moneybox, called for tougher penalties.

Liddell-Grainger, the Conservative MP for Bridgwater, said: "Everyone knows it is going on but it is hard to detect. Now VAT has gone up to 20% it will become much more high profile.

"Double the tax is no deterrent. If you've got a tax bill of £30, that is £60. In the worst cases it needs to be a custodial sentence, and certainly up to ten times the tax.

"You are going into people's homes, lying and using your position to extort money out of people. In any other walk of life you would be jailed."

How to spot a fraudster

If you are suspicious about a firm you can find out if the VAT registration number it uses is genuine.

The European Union has a website to check this. It is designed for businesses to use but is nevertheless accurate.

Alternatively, you can call HM Revenue and Customs (HMRC) during working hours to check, on 0845 010 9000. If you suspect fraud, you can call HMRC on 0800 595 000.

An HMRC spokesman says: "We use a range of penalties, including criminal prosecution to tackle those who seek to abuse the VAT system in this way."

What is VAT?

It is a tax owed by business, not consumers, though the extra cost usually translates into higher prices.

The amount of VAT owed by businesses jumped on 4 January from 17.5% of the cost price to 20%.

Further reading/Key links

Cut costs: High Street Haggling, Cheap Online Shopping
Catch a fraud: EU VAT checker