Director disqualification in the context of VAT fraud (SoS v Rosenblatt)

Joshua Shields, barrister at Exchange Chambers, considers the recent case of the Secretary of State for Business, Energy and Industrial Strategy v Rosenblatt which dealt with the issue of director disqualification in the context of VAT fraud and examines the implications for insolvency practitioners.

Original news

The Secretary of State for Business, Energy and Industrial Strategy v Rosenblatt [2016] EWHC 2821, [2016] All ER (D) 81 (Nov)

The Chancery Division held that the defendant would be disqualified from acting as a company director for 13 years, on account of his connections with a number of transactions that had involved the fraudulent evasion of VAT. At the very least, the defendant had willfully shut his eyes to the fact that all 43 of the transactions on which the claimant Secretary of State for Business, Innovation and Skills relied had been connected to the fraudulent evasion of VAT.

What practical lessons can those advising take away from this case?

Where a company has taken part in trading connected with fraud, there are generally features of the transactions that do not stand up to scrutiny. A director against whom a disqualification order is sought in those circumstances needs to approach the evidence objectively and to consider how the court will view the transactions. Given the possibility of giving an undertaking not to act as a director, it is essential to take a realistic view early on.

What was the background to the application, briefly?

The defendant had been running a company Brand Management Limited (Brand), which became insolvent. Following investigation, the Secretary of State brought these proceedings under section 6 of the Company Directors Disqualification Act 1986 (CDDA 1986) seeking an order that the defendant be disqualified from acting as a director. The grounds for the claim were that the defendant caused or allowed Brand to enter into wholesale transactions of alcohol that were connected with the fraudulent evasion of VAT, and that the defendant knew or should have known of this.

What were the legal issues the judge had to decide in this application?

For an application under CDDA 1986, s 6 to succeed, it must be shown that the:

  • defendant was a director of the relevant company
  • company became insolvent, and
  • director’s conduct as a director of that company makes him unfit to be concerned in the management of a company

Here, the defendant’s brother was the formally appointed director of Brand for most of the company’s existence. However, it was conceded that the defendant had acted as a director on the basis that he had run the company. It was likewise conceded that Brand became insolvent. Thus the issue for the court was whether the defendant was unfit to be a director.

There is a developing body of case law considering disqualification in the context of VAT fraud. The underlying jurisprudence stems from the decision of the Court of Justice in C-439/04: Axel Kittel v Belgian State [2008] STC 1537, where it was held that a trader who enters into a transaction connected with the fraudulent evasion of VAT is to be treated as a participant in the fraud if he either knew or should have known of the connection with fraud. The question addressed in Kittel was as to whether a trader in those circumstances was entitled to deduct or reclaim the input tax VAT arising in the transaction, and the Court of Justice held that a trader who was a participant in the fraud was not so entitled. The jurisprudence in this country has developed in the First-tier Tribunal (Tax Chamber) in the context of appeals by traders denied the right to deduct/reclaim input tax on Kittel grounds, and thus far the principles have twice been considered in the Court of Appeal (Mobilx Ltd (in administration) v Revenue and Customs Commissioners [2010] STC 1436 and Fonecomp Ltd v Revenue and Customs Comrs [2015] EWCA Civ 39, [2015] All ER (D) 19 (Feb)). The court has held that, in the context of an application under CDDA 1986, s 6, the Secretary of State is entitled to seek a disqualification order where a director has participated in a VAT fraud in the Kittel sense.

To succeed under Kittel, it must be shown that:

  • the trader entered into transactions connected with a tax loss
  • the tax loss was fraudulent, and
  • the trader knew or should have known of that fact

On an application under CDDA 1986, s 6 it must be further shown that the knowledge of the trader is to be ascribed to the director against whom the disqualification order is sought.

In Rosenblatt, it was conceded that Brand had entered into transactions that were connected with tax loss. That the tax loss was fraudulent was not admitted, and knowledge was denied. Those were the issues that the judge had to decide.

What were the main legal arguments put forward?

Relying on Fonecomp, it was argued for the Secretary of State that it is sufficient to constitute knowledge that a director knows or has the means of knowledge that fraud has occurred, or will occur, at some point in some transaction to which his transaction is connected. The participant does not need to know how the fraud was carried out in order to have this knowledge.

There was also an argument about the standard of proof. The court had to consider whether Re Bradcrown Limited [2001] 1 BCLC 547, [2000] All ER (D) 1657 remained good law. It was there said by Lawrence Collins J that while the standard of proof in disqualification proceedings was the civil standard of proof, the more serious the allegation, the more cogent the evidence the court will require. This preceded the decisions of the House of Lords in Re B (Children) [2008] EWCA Civ 282, [2008] All ER (D) 232 (Jan) and of the Supreme Court in Re S-B (Children) [2009] UKSC 17, [2009] All ER (D) 160 (Dec) where it was held in the context of family law that there was no heightened standard of proof in a civil case merely because the allegations are serious, and that the standard remains the balance of probabilities.

What did the judge decide, and why?

In terms of the law, the court accepted that the guidance in Fonecomp applied in the context of disqualification proceedings. It was accepted on behalf of the defendant that Bradcrown had been superseded, and the judge indicated his agreement with that concession.

In terms of the facts, the judge found:

  • that the tax losses with which Brand’s transactions were connected were fraudulent
  • the defendant to have displayed a lack of candour and honesty both in his dealings with HMRC and in his evidence to the court
  • that Brand had been set up to give the impression that the defendant’s brother was in charge of the company, when in fact it was the defendant, and that was a sham deliberately designed by the defendant to conceal his true involvement, because from the outset the company would be assisting in and facilitating VAT fraud
  • that commercial checks (referred to in the jargon of Kittel type cases as ‘due diligence’) carried out by the defendant were purely window-dressing
  • that the deal documentation was inconsistent with the defendant’s description of his business model

Taking all of the evidence into account, he held that the defendant had actual or at least blind-eye knowledge that his transactions were connected with the fraudulent evasion of VAT, and that he was unfit to be a director. The defendant was disqualified for 13 years.

To what extent is the judgment helpful in clarifying the law in this area?

Besides the clarification of the standard of proof in disqualification cases, the case is the first of its type to apply Kittel principles to purely domestic, as opposed to intra-community, transaction chains. While the principle as formulated in Kittel is expressed in sufficiently wide terms that it includes any VAT fraud, the disqualification cases considered hitherto have involved missing trader inter community trading. The judge had no difficulty in applying the principles to these domestic transaction chains.

Interviewed by Alex Heshmaty.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Further Reading

If you are a Lexis®PSL Subscriber, click the link below for further information:

What constitutes unfitness under s 6 Company Director's Disqualification Act 1986?

How can a director be disqualified as a company director?

Not a subscriber? Find out more about how Lexis®PSL can help you and click here for a free trial of Lexis®PSL Restructuring and Insolvency.

First published on Lexis®PSL Restructuring and Insolvency

Relevant Articles
Area of Interest