High Court: UK director ‘had knowledge’ of company’s VAT fraud

The High Court upheld an application made by the liquidator of JD Group Ltd (‘the company’) claiming that Deepak Bhatia, the company director, was engaged in fraudulent trading owing to knowledge that the company was associated with VAT fraud. Judge Agnello QC found that the manner in which the respective transactions were carried out provided clear evidence of this knowledge and that Bhatia’s conduct was dishonest in accordance with the objective standards of ordinary decent people.

• director had deliberately not undertaken due diligence on the transactions, which did not have a commercial nature
• not necessary for director to be aware of all previous parties involved in the chain of transactions concerning the goods
• JD Group Ltd, Re [2022] EWHC 202 (Ch)

The company traded in mobile phones and was involved in several importing and exporting transactions. The company imported goods from EU entities VAT free and then sold them onto UK entities subject to VAT, creating a VAT liability for which the company was required to account to HM Revenue & Customs (HMRC). The company also purchased goods from UK entities subject to VAT and then exported them onwards to EU customers VAT free. It attempted to use these latter export transactions to absolve the VAT liability it had with HMRC for its import transactions.

On assessing its tax return for 2005-06, HMRC denied the company tax credit on the basis that the export transactions were part of a fraudulent MTIC scheme. The company failed to pay the VAT liability, and HMRC presented a winding up petition. A winding up order was made against the company on 12 May 2014.

Michaela Joy Hall was appointed as liquidator of the company. She initiated proceedings against Bhatia, the director, based on evidence supplied by HMRC that the transactions were part of a fraudulent scheme across a series of entities, which had caused loss to HMRC, and that the director was aware of the company’s involvement in that fraud.

Judge Agnello QC considered that in order for the offence of fraudulent trading under section 213 of the 1986 Insolvency Act (IA) to be satisfied, the liquidator had to firstly prove that the director had subjective knowledge of the fraudulent activities being undertaken by the company and, secondly, that the director’s conduct was dishonest according to the objective standards of ordinary decent people.

Bhatia claimed that he was unaware that the company was participating in VAT fraud and that the company had stringent due diligence processes which took place prior to entering into transactions. However, the judge found that the supposed processes had deliberately not been carried out by Bhatia and that he had not undertaken several steps suggested by HMRC to mitigate the risks of being implicated in VAT fraud. Furthermore, the judge held that the transactions in question were not commercial in nature; lacking negotiations, terms and conditions, and often being entered into before payment was received.

Taking this combination into account, the judge found that: “It is not necessary for me to be satisfied that [Bhatia] was aware of the identity of other parties in the chain. In this case, the way in which the [company] conducted its business, the lack of checks, the release of goods and the other matters set out above, establish that [Bhatia] was aware of this being a fraudulent enterprise”.

Subjective knowledge was therefore established. Additionally, Bhatia’s conduct was dishonest “according to the objective standards of ordinary people”.

Notably, the judge also found Bhatia liable for breach of duty under section 212 of the IA. This section applies where, in the course of the winding up of a company, it appears that a person who is, or has been, an officer of the company has misapplied or retained any money or other property of the company. Bhatia was found liable as “the case against the Director on the grounds of fraudulent breach of duty is also established for the Director carrying out the business of the Company for the purposes of defrauding HMRC”.

Bhatia was ordered to contribute to the company’s assets an amount equal to HMRC’s claims in the liquidation of the company for the unpaid VAT liability and a misdirection penalty, for misdeclaration in the company’s 2005-06 tax return. This was because, had the VAT fraud not occurred, the company would not have been liable to account to HMRC.

Implications

This case is the first of its kind in which the director of a company has been held liable for both fraudulent trading and misfeasance for participation in MTIC fraud. It also revisits and provides further application of how the courts will determine the subjective standard of knowledge required for the offence of fraudulent trading. Notably here, it was not a necessary component that the director be aware of all previous parties involved in the chain of transactions concerning the goods.

Where a company purchases goods from a UK entity subject to VAT and then sells those goods to an overseas entity free of VAT, the company will typically be entitled to claim a net VAT credit. However, this case shows that a company may be denied such VAT relief where directors knew, or ought to have known, that the transactions were associated with VAT fraud.

Co-written by Dre Efthymiou of Pinsent Masons.