Overview Of Missing Trader Fraud And Bad News
Missing trader fraud was at the heart of the case of Re JD Group Ltd [2022] EWHC 202 (Ch).
On 7 May 2020 the Liquidator of JD Group Limited (“the Company”) issued an application under Section 213 of the Insolvency Act 1986 (Fraudulent Trading) and Section 212 of the Insolvency Act 1986 (Misfesance and Breach of Fiduciary Duty).
Winding Up History
On 9 May 2014, the Company went into a creditors voluntary liquidation. This was superseded by a winding up order made on 12 May 2014 on the winding up petition of HMRC.
The Main Protagonist
Mr Deepak Bhatia (“the Director”) had to answer the application. He was at all relevant periods sole Director of the Company.
Prior to 2005/2006, the Company had an established business of dealing in babywear. Its course changed after 2005/2006 when the Company ventured into the trading of mobile telephones.
To whet your appetite for the ‘bad news‘ that is coming, this is not a case in which litigants argue over chicken feed. Imagine that the Director was ordered to pay £1,785,892 to the Liquidator and you might not go far wrong.
Missing Trader Fraud Events Leading To Liquidation
The missing trader fraud events leading to Liquidation were summarised by the Judge as follows:
The Liquidator’s case derives from transactions, being the purchase and sale of mobile phones undertaken by the company during the period August 2005 to August 2006. In particular, the Liquidator relies on the VAT return for the period ended May 2006. In that period, the Company recorded 7 export transactions, being the purchase of phones from 2 UK suppliers, Mana Enterprises Ltd (‘Mana’), Regal Portfolio Ltd (‘Regal’) and sale to 3 overseas purchasers – URTB Sarl (‘URTB’); Compagnie Int’l de Paris SARL (‘Compagnie Paris’) and Rakha SARL (‘Rakha’). The total VAT paid by the Company to the 2 UK suppliers in these chains was £2,117,762. In the May 2006 VAT return, the Company sought to claim this sum as part of its total input deductions of £37,943,297 to set off against its output tax liability on its sales. The Company recorded total output tax liabilities of £37,072,271 in this period, consisting of both UK to UK sales and the output tax liability on 5 import transactions. These 5 import transactions consisted of purchases from a single supplier, a Polish registered company, Pol Comm Trading sp z o.o (‘Pol Comm’) and the onwards sales all to the same company, being the The Export Company (UK) Limited (‘TEC’). The total output tax liability in respect of those sales was £1,243,200. After conducting a verification exercise into the Company’s claim to offset the £2,117,762 input tax on the 7 export transactions, it disallowed the claimed credits on the basis that (1) the Company knew or had the means of knowing that those transactions were connected to missing trader intra community VAT fraud ( MTIC fraud); (2) HMRC had suffered a tax loss in those transaction chains in that each one could be traced back to a defaulter who had deliberately not paid its output tax liabilities. The effect of this disallowance of the input tax liability was that the Company was left with a net VAT liability of £1,246,736.17 in respect of the March – May 2006 period which primarily comprised of the £1,243,200 output tax within the 5 import transactions.
On 3 September 2008, the Company appealed to the First Tier Tribunal against the refusal by HMRC to allow the claimed input tax credit. This appeal was combined with the appeal issued on 17 December 2007, by JD Net Solutions Ltd, being another company which had traded in mobile phones and where at the relevant time, the Respondent was also a director. Extensive evidence was served by both the Respondent on behalf of the Company and by HMRC. The witness statements filed by the Respondent in the Tribunal proceedings were exhibited by the Respondent and relied upon as part of his defence to these proceedings. The Liquidator also sought to rely on the extensive evidence served by HMRC in those proceedings. Mr Kevin Pettican, Counsel on behalf of the Respondent, made the point before me that all the documentation which was before the First Tier Tribunal may well not have been before me. I entirely accept that might be the case, but the witness statements filed on behalf of the Company by the Respondent are in the evidence alongside those filed by HMRC.
This enables me to see the evidence relied upon, including any documentation exhibited and relied upon, as well as consider the points made by the Company in its appeal. This remains the case even taking into account that there may well have been documents included in bundles for the purpose of the First Tier Tribunal hearing which were not before me. Mr Shaw did not suggest that all the documents which had been filed before the First Tier Tribunal were before me.
On 29 February 2012, the Tribunal directed that unless the Company confirmed within 21 days its intention to proceed with the appeal, it would be struck out. As there was no response from the Company during the requisite period, the appeal was thereafter automatically struck out on 22 March 2012. No application was made by the Company seeking to reinstate the tribunal process.
On 21 March 2014, HMRC issued an assessment for a misdeclaration penalty pursuant to section 63 of the VAT Act 1994 in the sum of £285,897 in respect of the misdeclaration in the May 2006 VAT return relating to the claimed and disallowed input tax credits. There was no appeal by the Company against that assessment. HMRC’s VAT claim in the liquidation is the sum of £1,286,470.78 and £285,897.
Was It Missing Trader Fraud?
Missing trader fraud has been summarised in the court decision Natwest Markets Plc v Bilta (UK) Ltd & Ors [2021] EWCA Civ 680 at [4] and [5].
The Court here assessed that the impugned transactions amounted to missing trader fraud because of the chain of transactions :
… in many instances occurring on the same day, the mark ups being very small until the export transaction. Additionally, there are instances where the evidence demonstrates that the goods were ’sold’ before any payment was made. The prices of the units themselves did not appear to reflect any commercial negotiation because the mark ups remained, in many instances, the same regardless of a unit price. There is a real lack of commerciality when the chains are examined to the extent that these chains are clearly, in my judgment operated for the purposes of MTIC fraud.
The Dishonesty Tests
The Court referred to the two tests for the assessment of dishonesty:
It is common ground that the Liquidator needs to establish that the Respondent was dishonestly causing the Company’s participation in the MTIC fraud described above. Both parties referred me to the two fold test for dishonesty set out in Ivey v Genting Casinos [2018] AC 391 at paragraph 74:-
“When dishonesty is in question the fact-finding tribunal must first ascertain (subjectively) the actual state of the individual’s knowledge or belief as to the facts. The reasonableness or otherwise of his belief is a matter of evidence (often in practice determinative) going to whether he held the belief, but it is not an additional requirement that his belief must be reasonable; the question is whether it is genuinely held. When once his actual state of mind as to knowledge or belief as to facts is established, the question whether his conduct was honest or dishonest is to be determined by the fact-finder by applying the (objective) standards of ordinary decent people. There is no requirement that the defendant must appreciate that what he has done is, by those standards, dishonest”
Knowledge includes what is called blind eye knowledge. A person’s belief may include suspicion which falls short of blind eye knowledge. Again, none of this was really contradicted by Mr Pettican. The test was paraphrased in NatWest v Bilta, paragraph 130, is where dishonesty is in question, the fact finding tribunal must ascertain (i) the defendant’s actual state of knowledge and belief as to the facts, and (ii) whether in the light of that state of mind, their conduct was honest or dishonest applying the objective standards of ordinary decent people. So, “the honesty of a person’s conduct falls to be considered objectively in the light of all relevant material including their state of mind.”
The two stage test set out in Ivey and approved in Nat West v Bilta requires little further elaboration, but it is important, in my judgment not to confuse the two parts. The first fact finding exercise and ascertaining what was the Respondent’s actual state of knowledge and belief as to the facts requires me to consider carefully the evidence before me including, the evidence given by the Respondent before me. The second part requires an application of the objective standard of ordinary decent people to determine whether that state of mind was honest or dishonest.
…
… a person can be held to be dishonest even if he believes his conduct was not dishonest. That is the effect of limb 2 which is in my judgment entirely sensible for the reasons set out by Lord Hughes. Accordingly, I do not accept the proposition of Mr Pettican that if I find the Respondent honestly believed that the transactions were effectively commercial transactions and that they were not part of MTIC fraud, then that is effectively the end of the matter.
Notification From HMRC To The Director About Missing Trader Fraud
A significant issue for the Director was that HMRC sent notifications to the Company about missing trader fraud and that the nature of the Company’s trading placed it at risk of being implicated in fraud.
The HMRC notices set out details for the Director as to what steps ought to be taken to guard against being caught up in such fraudulent activity.
The Due Diligence Assessment
The Court was simply unimpressed with the Director’s evidence as to the due diligence asserted to have been undertaken by the Company to vet transactions. The Court considered that there was an inherent lack of commerciality about many of the transactions in light of:
- absence of negotiations
- absence of terms and conditions
It appeared to be pseudo-due diligence because the Judge went through a series of examples of transactions and picked out some of the highlights which showed why the Court should not consider that the Director had properly undertaken the requisite procedures:
In my judgment, the Respondent was well aware that the due diligence he asserted was being carried out was not being carried out. There was, in my judgment, no genuine attempt to deal with the matters raised by HMRC in the Notice. In my judgment, the Respondent sought to create files which were designed to create an impression that due diligence was carried out. His assertions in his witness statements about the due diligence and the Company having robust procedures were not truthful. This finding clearly has a bearing on what the Respondent knew and believed. He clearly knew that the due diligence carried out was pretty much meaningless and that he was allowing the Company to enter into substantial transactions which had all the hallmarks of being part of MTIC fraud. Mr Pettican submitted that none of the Company’s suppliers were VAT defaulters and all that the Respondent could reasonably be expected to investigate are his own suppliers and customers. In my judgment, those points do not provide any defence to the Respondent in circumstances where MTIC fraud had been explained carefully to him by HMRC in documents and at meetings. The fact remains that no real due diligence was carried out, not even on the immediate suppliers or customers. This was clearly in my judgment deliberate. Based on the evidence, any proper due diligence would have exposed that there was a real lack of integrity in the supply chains and an open awareness that the chains were part of MTIC fraud. Instead the Respondent sought to disguise the lack of due diligence by relying on cursory checks carried out on the day of certain transactions or post dating the transactions themselves. There is really no explanation provided by the Respondent as to why the Company singularly failed to carry out proper due diligence before these high value transactions This is especially of concern in this case where the Respondent’s level of knowledge about MTIC, steps to take, potential liability of the Company was extensive and where he had stated in his evidence that the Company had robust procedures and that it followed everything set out in the Notice. That was clearly not true.
There were other aspects of the transactions relied upon by the Liquidator in order to establish that these were not commercial transactions. There was an absence of any evidence of terms and conditions of purchase and supply, no terms of delivery, passing of risk, retention of title etc. When asked, the Respondent stated that the Company did have some terms and conditions but they were fairly rudimentary. He said upon request the Company would send these to the other party. I find this pretty astonishing bearing in mind the value of the trades with parties completely unknown to the Company. In the event that the goods were faulty, then terms would have to deal with the return of goods. None of this appeared to have perturbed the Respondent as the sole director of the Company in committing the Company to large transactions without any terms having been agreed. This again goes towards the lack of evidence that these were commercial transactions.
Equally, there was no evidence of any negotiations between the Company, its suppliers and its buyers in relation to the price of the goods or any other conditions of the purchase and sale. There is no evidence in relation to even one price negotiation, no written communication over price, delivery dates, specifications or insurance. At one stage, during his cross examination on this topic, the Respondent sought to rely on the invoice as being the reference to the negotiations. In my judgment, the Respondent was effectively seeking to deflect from the fact that he was unable to demonstrate in reality that the transactions were genuinely commercial transactions. As I have already stated above, I have been careful not to lose sight of the fact that events relied upon took place many years ago. However, in this case, the Company pursued (until it abandoned subsequently) an appeal at a much earlier stage. The Company was still in existence and trading at the time that the Appeal was pursued and evidence was served and filed. In my judgment, the Respondent was well aware of the way that HMRC, in its decision to reject the VAT claim of the Company, relied upon the way the transactions occurred and the lack of due diligence. It is in my judgment, significant that no evidence of negotiations as to price, actual due diligence or any evidence demonstrating the pre transaction negotiations was submitted as part of the Company’s case.
And Now For The Bad News
There was a curious reference in the Judgement to an explanation from the Director about some “bad news” that he said impacted on his ability to answer questions when being subjected to cross-examination. The Court disposed of this anomaly as follows:
In re examination, the Respondent raised the issue that he had received some bad news in the morning and was concerned that this may have affected his ability to reply to questions. I appreciate that the bad news may have affected the Respondent to an extent, but during the entirety of his cross examination, I did not find the Respondent to be truthful. I am not persuaded that the bad news he received in the morning was such that he gave untruthful answers before me during the entirety of his cross examination.
Result Explained
The Court’s central conclusion was articulated as follows:
Based on these factors, in my judgment, the Respondent was aware that these transactions formed part of MTIC fraud. I reject accordingly his evidence that he was unaware of the MTIC fraud and I also reject his evidence that he honestly believed that these were commercial transactions and that there was he believed no link to MTIC fraud. Such a stance is not credible in the light of my findings on the evidence set out above. In my judgment, as is clear from the authorities that I have referred to above, it is not necessary for me to be satisfied that the Respondent was aware of the identity of the 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 the Respondent was aware of this being a fraudulent enterprise. The Respondent deliberately elected not to carry out proper due diligence and other steps suggested by HMRC. This, in my judgment, was precisely because he was aware that the chains were part of a MTIC fraud. Accordingly, in my judgment, the Respondent knew that the Company was participating in a MTIC fraud. It is clear that such participation is dishonest under the objective standards applicable. The transactions were not genuine commercial transactions but were created and carried out exactly as described above in relation in the extracts from the various cases. Accordingly, in my judgment, the Respondent is liable pursuant to section 213 of the Insolvency Act 1986 in dishonestly causing the Company’s participation in the MTIC fraud. Bearing in mind the findings I have made, there is no need for me to deal with blind eye knowledge.
Oliver Elliot Comment
If you are going to engage in the trade of mobile phones then you will need to be able to demonstrate clearly that you have engaged in real and commercial transactions with your customers and suppliers.
Such has been the extent of the VAT fraud losses suffered by HMRC over the years that the burden is very much on a party trading in such seemingly risky products. One really has to in effect be able to prove transactions and trades have been genuine and provide bona fide evidence of due diligence and checks being undertaken.
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