“Reasonable grounds for knowing or suspecting”: a cautionary tale about VAT fraud
06 Feb 2017

Missing trader fraud

An HMRC study on the 2014-15 tax year estimates that there was a gap of £12.7 billion between the VAT theoretically due and the amount actually collected. Up to £1 billion of the missing money is thought to have been lost to so-called ‘missing trader’ fraud. This is an improvement on years gone by: a study on the 2005-06 tax year estimates the UK’s annual losses in tax revenue to missing trader fraud at £2-3 billion.

Missing trader fraud relies on the fact that no VAT is due on goods imported into the UK from overseas. Its most basic form is Acquisition fraud:

  1. The ‘missing trader’ purchases goods from an overseas supplier. No VAT is due
  2. The trader resells the goods in the UK, charging buyers VAT
  3. The VAT received from buyers is owed to HMRC but the trader does not pass it on

Carousel fraud is an extrapolation of the same principle:

  1. The ‘missing trader’ buys goods from an overseas supplier. The transaction is VAT exempt
  2. The trader resells the goods in the UK, adding VAT to the price
  3. The goods are sold between businesses in a chain of legitimate transactions. Any excess VAT resulting from a mark up in price is, as it should be, passed on to HMRC
  4. The final buyer in the chain, known as the broker, exports the goods back overseas. Because the transaction is VAT exempt, the broker can recoup the VAT she paid on the goods from HMRC. In doing so she effectively claims back the VAT that the missing trader never paid

The fraud is a ‘carousel’ because the same goods can be sold repeatedly round the chain.

The Proceeds of Crime Act: a cautionary tale

Not everyone involved in the fraud is a trader: legal professionals and corporate service providers are required to set up and administer the carousel, and profits are laundered in any number of ways. Anyone who counsels, aids or abets is liable for a money laundering offence under the Proceeds Of Crime Act 2002. In addition, under 5.4.3 Section 328 of the act, a person commits an offence if he enters into or becomes concerned in an arrangement which he knows or suspects facilitates the acquisition, retention, use or control of criminal property by or on behalf of another person.

A recent case saw a solicitor convicted of suspecting the facilitation of something illegal when his clients turned out to be involved in a carousel fraud. Graham (not his real name) is an experienced music lawyer with a City background who, at the time of his conviction, had a client list that included some of the biggest names in the industry.

The music business has more than its share of quirks: well-known artists often travel under aliases to avoid attention, tour the world over, and use innovative structures, including import-export arrangements, to circumvent foreign exchange controls when earning royalties in far-flung places. According to The Guardian, Abba’s outrageous outfits in the 70s and 80s were due in part to exemptions in the Swedish tax code for clothing that ‘could not possibly be worn on the street’. On top of this, work comes and goes and even established artists sometimes find themselves needing to set up side-businesses to supplement intermittent income.

It was a problem with such a side-business led one of Graham’s longstanding clients to get in touch with him. The client had been making a reasonable profit importing recording equipment into the UK until, out of the blue and with no explanation offered, his bank shut down his account.

Graham looked into the matter and found that the client’s business appeared somewhat fly-by-night, with no permanent presence on the ground in Asia. Graham flew out, met with banks and accountants and filed the paperwork to establish a company locally. The firms with which the client was trading were happier to receive funds from an account linked to an Asian company than from a personal UK account, and business picked up again.

Over the next few months the client introduced Graham to a number of associates who were also keen to formalise business with Asian companies. Graham put them in touch with local accountants and helped them establish the corporate structure used frequently in the music industry: a UK company with a UK bank account, linked to an offshore company and bank account in the same name. His list of clients for company formation services kept growing, to the extent that, after six months or so, it seemed like a good idea to set up a permanent office in the region.

Graham benchmarked his business practices against other successful company formation service providers and, in accordance with the anti-money laundering regulation at the time, met every customer in person and verified their passport and address. Proxy directors and board members were offered but the beneficial ownership of the companies was a matter of public record. Graham kept careful paper records too—three filing cabinets worth—with copies in Asia and London. He went together with customers to banks, who duplicated his due diligence before opening accounts.

And then one morning, about a year after he opened the Asian office, Customs officers turned up at Graham’s house at half seven in the morning and took him to the police station. They put him in a cell, called a lawyer and, eventually, granted bail at £100,000.

Graham was charged with involvement in a carousel fraud claimed to total, by the time he was convicted, more than £200 million. About a fifth of this was said to have been laundered through companies Graham helped to set up, although Graham himself was charged with less than £100,000 in above-board client fees.

The criminal group behind the fraud, in which neither Graham nor his client were accused of playing a pivotal role, submitted fake invoices in the names of existing British companies. Buyers were told to make payments to the bank accounts of clone firms in Asia. This, it was held, allowed goods to be bought and sold repeatedly between the UK and VAT-free jurisdictions, with the VAT fraudulently claimed back from the government each time.

Graham spent a month in a cell before the £100,000 bail, which had to be paid in cash, could be gathered from family and friends. During the several months of trial and in the year leading up to it, Graham’s bank accounts were frozen and he and his family were reliant on benefits. His children were taken into the protection of family and friends.

To convict Graham of money laundering under the Proceeds of Crime Act, the Crown had to show that the relevant act—helping set up companies in Asia—was committed despite the defendant knowing or suspecting that the property involved was derived from criminal conduct. At the start of the trial Graham was depicted as a kingpin of the whole carousel. This didn’t stick, although Graham is still angered by the accusation, joking that if he were a master criminal he would, he likes to think, have been doing better for his family than a two bedroom house and an M-reg car.

As the trial progressed it was established that Graham had been running a legitimate business that was abused by criminals. No money went through his personal accounts and his only profit was legitimate fees for services. So the Crown’s case hinged on that key provision, unusually stringent in the UK legal system: knowing, or merely suspecting, the criminal origins of the property involved.

The prosecution claimed that a number of things—companies in two jurisdictions with the same name, clients with alias passports, and bank accounts closed at short notice—were red flags. Graham doesn’t deny this, although he points out that the first two are not unusual in the music industry. He wonders whether his client, who pleaded guilty and was given an eight year sentence, recognised and exploited this blind spot.

I asked Graham if there was ever a point during the trial when something clicked, when he thought: “how did I miss it?”. He says not. He never had an inkling before police turned up at his door that anything approaching criminal was going on.

The prosecution ultimately accepted that Graham didn’t have direct knowledge of the criminal origins of the money, but not that he didn’t suspect foul play. ‘Suspicion’ became the keyword of the trial. In his closing speech, the QC for the prosecution said that while Graham had not acted illegally for profit, he had turned a blind eye to criminal activity in order to provide for his family—and that that was no excuse.

Graham was given a six year sentence, and his house was seized and sold off against his fine. He appealed immediately but served 18 months while he waited for the case to be heard. The appeal package consisted only of character statements and brought no new evidence, but it saw his sentence reduced, for the benefit of his children, such that he was let out on tag a few weeks after the completion of the appeal.

Although Graham can still practise law, he now only acts as a consultant. If clients Google him and find press coverage of the conviction, the best spin he can offer is: “I know things that no other lawyers or consultants know”—but he’s not really comfortable with the line. He still feels keenly in such circumstances that he has to defend himself again, to try to convince the client of his innocence. And in doing so, everyone he tells becomes a new jury, judging on something—the presence or lack of suspicion—that is more or less unknowable.

Amos Wittenberg, Editor, KYC360


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