Director of company involved in a VAT carousel fraud ordered to pay £1.7m to liquidator for fraudulent breach of duty
In the case of Re: JD Group Ltd (Hall v Bhatia  EWHC 202 (Ch)), the High Court held that a director was liable for fraudulent trading under s.213 of the Insolvency Act 1986 ("IA 1986") and fraudulent breach of duty under s.212 IA 1986, because he knowingly involved the company in missing trader intra-community fraud ("MTIC Fraud"). MTIC Fraud is a type of cross-border tax fraud which exploits the zero-rating of VAT across borders between member states and involves a conspiring party not paying output tax liabilities to HMRC. MTIC Fraud involving electronic goods was particularly prevalent in the mid-2000's, however it continues to cost EU taxpayers an estimated €20-100bn per year.
The respondent (the "Director") was the sole director of JD Group Limited (the "Company"), which had been involved in the business of buying and selling babywear from its inception in 2001 until 2005. Between August 2005 and May 2006, the Company was a party to a series of transactions involving the import and export of mobile phones. When HMRC conducted verification relating to the company's claim of £2,117,762 in input tax credits, they discovered the transactions were entirely artificial and purely for the purposes of facilitating MTIC Fraud. Following an HMRC investigation and resulting First Tier Tribunal, the Company was issued with a misdeclaration penalty of £285,897 from HMRC. HMRC's VAT claim in liquidation stood at £1,286,470.48.
Liquidator's claims against the Director
The liquidator's claims against the Director could be separated into two parts:
- Section 213 claim: The Director was a knowing party to the carrying on of the Company's business with the intent to defraud HMRC; and
- Section 212 claim: The Director acted in (i) fraudulent breach of duty, or (ii) breach of duty to act honestly, bona fide or to exercise his directorial powers for the purposes for which they were conferred
The loss claimed by the liquidator under the s.213 claim amounted to £457,897. This figure was calculated as being the net VAT loss to HMRC when compared to the position HMRC would have been in if the transactions had been entered into genuinely and were not part of a fraudulent scheme.
The loss claimed by the liquidator under the s.212 claim amounted to £1,501,995. This figure was the loss suffered by the Company itself (as opposed to the net loss suffered by HMRC). It is calculated as being the total input tax which the Company paid to suppliers (£2,117,762) minus the Company's net profit on the export transactions (£615,767). The liquidator also claimed the £285,897 misdeclaration penalty, being a debt which the Company owed to HMRC as a result of the Director's actions.
The Court was satisfied from the evidence that the Director had actual knowledge of the MTIC fraud. It was clear from the facts that the Director knew the Company was participating in an MTIC fraud and his actions were dishonest under both the subjective and objective tests as set out in Ivey  AC 391. It was no defence that the Director did not know every minor detail of the fraud, or even the identities of some of the other parties in the transaction chains. In fact, the evidence showed that the Director had deliberately elected not to carry out proper due diligence on the other parties to the fraudulent transactions. In addition, the Director had ignored several HMRC notices which specifically warned the Company about the widespread use of telephones in MTIC Fraud and the risks to the Company if implicated in MTIC Fraud (which included the risk of being liable for the net tax unpaid on those goods).
Therefore, the Court ruled that the Director was liable for fraudulent trading under s.213 IA 1986 and fraudulent breach of duty under s.212 IA 1986. Given the Director's breach of duty was based on fraud, the action was not subject to a limitation defence under s.21(1)(a) of the Limitation Act 1980. Interestingly, the Court indicated that there was no reason to restrict the quantification of the loss to the smaller of the two claims, as long as the Court was satisfied that the sums claimed were the losses suffered. The Director was ordered to pay the sum of £2,117,762, less the profits enjoyed by the Company and including the HMRC penalty.
The case was an unusual example of a liquidator bringing a claim against a former director for fraudulent trading. Interestingly, the liquidator's claim was successful primarily because of historic documentary evidence (which had been adduced at the First Tier Tribunal over a decade ago) rather than evidence which she was able to produce. In fact, the Court noted that the liquidator's evidence was of limited use since she had no actual knowledge of the events. Further, the Director's evidence, which he gave in his defence was found to be dishonest and not credible after almost a day of cross-examination.