Director liable for fraudulent trading for not investigating VAT fraud - ignore HMRC at your peril

A recent High Court decision (JD Group Ltd [2022] EWHC 202 (Ch)) has found a director liable for fraudulent trading when he was aware that the company was participating in VAT fraud and deliberately failed to investigate. This decision has ramifications for directors and companies.

Background to the case

The company started trading in baby clothes, and later in mobile phones. When HMRC assessed its 2005/2006 tax return it declined its claim for tax relief in respect of a series of related import and export transactions, the effect of which was VAT fraud. HMRC suggested that the company undertake various steps to avoid this, such as investigating counterparties.

The liquidator subsequently brought a claim against the director for fraudulent trading (sec. 213 Insolvency Act 1986). The liquidator relied on HMRC’s analysis of the VAT fraud.

The court confirmed that the liquidator had to satisfy a two-stage test. First, to demonstrate the director’s subjective state of knowledge; and then to show that the director’s conduct was dishonest based on the objective standards of ordinary decent people (Bilta (UK) Ltd (In Liquidation) v Natwest Markets Plc [2020] EWHC 546 (Ch)).

The director argued that he did not know the company was participating in a VAT fraud. He claimed the company had robust pre-transaction due diligence processes and, as a result, he believed the transactions were genuine.

The outcome

The court held that the director’s defence was not credible. There was no evidence that due diligence was being carried out, the transactions were back-to-back and often entered into before payment was received. The evidence showed that the transactions were uncommercial.

The court concluded that the director was, therefore, aware that the company was participating in a fraud, and that the director deliberately decided not to carry out due diligence and other steps suggested by HMRC. The director’s conduct was dishonest by the objective standards of ordinary decent people and he was, therefore, liable for fraudulent trading.

The court ordered the director to contribute an amount equal to HMRC’s claims in the liquidation for unpaid VAT to the company’s assets, plus a misdirection penalty (for misdeclaration in the company’s 2005/2006 tax return). This was on the basis that, had the VAT fraud not occurred, the company would not have been liable to HMRC.

Our advice?

Our advice to directors facing a similar situation would be to implement (and never ignore) measures suggested by HMRC to mitigate the risks of companies being implicated in tax fraud, and consequently mitigate a director’s risk of finding themselves subject to a similar claim.