Civil interventions for tackling MTIC fraud: a UK...

to authorise the action by the company. In any legalproceedings, no person may rely on such limitation,restriction or qualification to assert that such an action isvoid. Exceptions are proceedings between the companyand its shareholders, directors or prescribed officers, orbetween the shareholders and directors or prescribedofficers of the company. The similarity between section20(1) of the new Companies Act and section 36 of thepresent Act is striking. Even the criticised expression “thedirectors” has been retained.

In terms of section 20(7) of the new Act an outsiderdealing with a company in good faith is entitled to presumethat the company, in making a decision in the exercise ofits powers, has complied with all of the formal andprocedural requirements in terms of this Act, itsmemorandum of incorporation and any rules of thecompany unless, in the circumstances, the person knew orreasonably ought to have known of any failure by thecompany to comply with any such requirement. Adirector, prescribed officer or shareholder of the companyis not regarded as an outsider. The new Companies Actstipulates that this provision must be construedconcurrently with, and not in substitution for, any relevantcommon law principle relating to the presumed validity ofthe actions of a company in the exercise of its powers. Theprimary, if not the only, “common law principle” in thisregard is contained in the Turquand-rule.

Clearly, the new Companies Act creates a far morecomplicated legal position in regard to capacity andrepresentation than the Act. This is especially so because ofthe continued, though limited, application of complexcommon law doctrines and their accumulated learning tocompanies, even small one-man or closely-held privatecompanies.

It amply illustrates the difficulty to cater for thereasonable needs and expectations of all types and sizes ofcompanies, their stakeholders and persons dealing withthem, with a “one size fits all” approach.

Continuation of existing close corporationsThe new Companies Act provides for its co-existence

with the Act. It amendments the latter extensively “toavoid regulatory arbitrage”. The new Companies Actrepeals the present Companies Act and amends the CloseCorporations Act as provided for in Schedule 3. The resultis the indefinite continued existence of the Act and thus ofexisting close corporations. Close corporations willcontinue to exist until deregistered or dissolved in terms ofthe Act or converted to companies under the NewCompanies Act.

New close corporations proscribedFrom the effective date of the coming into operation of

section 13 of the new Companies Act, the incorporationof new close corporations will be proscribed. Thus new

close corporations can still be registered until the cominginto operation of section 13 of the Act. In terms of section225, the new Companies Act comes into operation on adate fixed by the President by proclamation in the Gazette.That date may not be earlier than one year following thedate on which the President assented to the Act, namelyApril 8, 2009. Obviously that date may be later than oneyear after the date of assent.

Conversion of companies into close corporationsproscribed and conversion of close corporations intocompanies facilitated

From the date on which Schedule 2 of the newCompanies Act comes into operation the conversion ofcompanies into close corporations will be proscribed.Until that date companies can still be converted into closecorporations under section 27 of the Act.

Schedule 2 provides for the conversion of existing closecorporations into companies under the new CompaniesAct. A close corporation may file a notice of conversion inthe prescribed manner and form, with a filing fee, at anytime. The notice must be accompanied by a certified copyof a “special resolution” approving the conversion of theclose corporation, and either a new memorandum ofincorporation, or an amendment to the existingmemorandum of incorporation complying with the newCompanies Act.

It is clear that a member of a close corporation will infuture no longer be faced with an obligation to become amember of the company upon conversion, but will havethe freedom of choice to decide whether or not to becomea shareholder of that company.

Section 14 of the new Companies Act, read with thechanges required in context, applies with respect to thefiling of a notice of conversion, as if it were a notice ofincorporation in terms of the new Act. Every member ofa converted close corporation is entitled to become ashareholder of the company, but the shares need not be inheld in proportion to the members’ interests.

Upon conversion of a close corporation in terms ofSchedule 2, the Companies and Intellectual PropertyCommission must cancel the registration of the closecorporation in terms of the Close Corporations Act, givenotice in the Gazette of the conversion of the closecorporation into a company and enable the Registrar ofDeeds to effect the necessary changes resulting fromconversions and name changes.

On the registration of a company converted from a closecorporation, the juristic person that existed as a closecorporation before the conversion continues to exist as acompany. All the assets, liabilities, rights and obligations ofthe close corporation vest in the company. Existing legalproceedings are deemed to have been done by or in respectof the company, and the liability of any member for the 25

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Missing trader intra community or MTIC fraud hasbeen a problem across the European Union forover 10 years, and much has been written about

its effects and how best to tackle it. So what is MTIC fraudand why does it pose such a challenge to taxadministrations across the EU?

In order to understand how MTIC fraud is perpetrated,it is important first to understand how the VAT systemfunctions. VAT is a consumption tax, operating via afractionated collection system, the VAT on the value addedat each stage of a supply chain is paid to the tax authorityby VAT-registered businesses. When a business sells goods,the supplier will charge VAT (output tax) on the price ofthe goods. It will normally deduct from the output tax anyVAT incurred on its purchases (input tax) relating to thesupply of the goods and pay the net amount to the taxauthority. This way the cost of VAT is only borne by thefinal consumer of the supply.

VAT is charged by all Member States of the EU.However, transactions between VAT-registered persons indiffering Member States (intra community transactions)are exempt from VAT (zero rated). The customer isresponsible for payment of the VAT on its intra-community purchases but retains the normal right todeduct input tax. In these circumstances the customereffectively has in its hands VAT-free goods (or services).

MTIC fraud exploits this zero-rated supply acrossnational boundaries as a means for stealing revenues fromnational states (carousel fraud) or creating a VAT debt to beused as a subsidy for undercutting legitimate supplies(acquisition fraud). The fraud is perpetrated when abusiness obtains a VAT registration number in one EUMember State, often with the sole intention of purchasinggoods VAT-free from a business in another EU MemberState and then selling them on to another business at aVAT-inclusive price but without paying the VAT charged totheir tax authority.

In many cases the fraudulent business “disappears”immediately. Such businesses are often called “missingtraders.” In some circumstances, the registered businesswill keep on trading and building up a debt until the taxauthority finds them and takes action to close down thecompany. Such businesses are often referred to as“defaulting traders.”

MTIC carousel fraud is a financial fraud and not acommodity based fraud, carried out with the sole aim ofsubmitting a fraudulent VAT repayment claim (or toreduce the amount of VAT that a business pays to thenational tax administration). Goods are typically importedVAT-free from another EU Member State and then passedthrough a chain of contrived transactions before being re-exported. As the goods are being exported, the goods willbe sold VAT-free, thus creating a large VAT repayment forthe exporting trader, (known as a broker); the repaymentbased on the VAT paid to its supplier. The transactionchains are contrived in a way that ensures that at or nearthe beginning of the transaction chain one of the traderswill ‘go missing’ to avoid paying VAT to the tax authority.The goods will usually pass through a series of VATregistered businesses, (known as buffers) to distance thebroker from the missing trader before being re-exported.If the VAT repayment return submitted by the exporter ispaid, it crystallises the unpaid paper debt accumulated bythe missing trader.

Figure 1 gives an illustration of a typical MTIC chainshowing both the movement of money and invoicedtransaction. In an MTIC carousel fraud, the same goodscan be repeatedly imported, sold and then exported, eachtime creating a repayment claim, hence the term carousel.In some cases there may be no goods at all, simply a seriesof paper transactions. As a rule, all of the traders within thesupply chain will be aware of the fraud and working activelyto facilitate its operation.

MTIC acquisition fraud differs from carousel fraud in thatthe goods are eventually sold for retail consumption. In thiscase, the VAT charged but not paid to the tax authority bythe missing or defaulting trader forms the profit, enablingfraudsters to undercut genuine trade.

The impact of MTIC fraud on tax receipts can besubstantial, particularly carousel fraud, which because of itscontrived nature has no theoretical limit. Since 1999, thegovernment has published estimated losses from MTICfraud in the Pre-Budget Review, (PBR) which is publishedin the autumn. The levels of fraud peaked in 2005/06, (seefigure 2) where losses were estimated at between £3.0billion and £4.0 billion. Since then, a combination of bothlegislative and operational changes has enabled the UK toreduce losses by at least 38 per cent.8


Civil interventions for tacklingMTIC fraud: a UK perspectiveby Steven Pope and Roderick Stone


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Then again, under section 57(2) of the new CompaniesAct, if a profit company (other than a state-owned company)has only one shareholder, the shareholder may exercise any orall of the voting rights pertaining to that company on anymatter, at any time, without notice or compliance with anyother internal formalities, except to the extent that itsmemorandum of incorporation provides otherwise. Inaddition its governance is exempted from the detailedrequirements of sections 59 to 65 of the new Companies Act.

In terms of section 57(3) of the new Companies Act, ifa profit company (other than a state-owned company) hasonly one director that director may exercise any power orperform any function of the board at any time, withoutnotice or compliance with any other internal formalities,except to the extent that the company’s memorandum ofincorporation provides otherwise. In addition sections71(3) to (7), 73 and 74 do not apply to the governance ofsuch a profit company.

Section 57(4) of the new Companies Act stipulates thatif every shareholder of a company (other than a state-ownedcompany) is also a director of that company any matterthat is required to be referred by the board to theshareholders for decision may be decided by theshareholders at any time after being referred by the board,without notice or compliance with any other internalformalities, except to the extent that its memorandum ofincorporation provides otherwise.

Single Act approachThe approach of the drafters of the new Companies Act

by preferring a single Act for small and large businesses andby de-emphasising the close corporation, throughadditional onerous regulation and prohibiting theformation of new ones, contrasts with the basic philosophyunderlying the Act that proved so successful. At the root ofthe development of the Act is the conviction that it is verydifficult for a single Act to provide a satisfactory legal formfor both the large and sophisticated as well as the small andoften marginalised entrepreneur. Historically, SouthAfrican company legislation developed mainly in responseto the needs of and problems posed by large publiccompanies. It had to provide for the large industrial orfinancial conglomerate with its listed shares andprofessional management reflecting a clear separationbetween ownership and control, or direct and indirectcontrol of say an institutional investor, scattered andpowerless small shareholders and group problems. Henceit inevitably outgrew the needs and problems of the smallentrepreneur who, typically, has restricted means andlimited access to professional advice.

As far as the new Companies Act is concerned, a case inpoint is the dispensation concerning capacity andrepresentation, which are applicable to both public andprivate companies alike, whether closely-held and/orexempted or not.

The ordinary rules of agency provide the foundation forthe representation of juristic persons, but have not beenable to supply solutions in all cases. A special orcharacteristic branch of agency has consequently developedwith specific common law doctrines such as the doctrine ofconstructive notice, the ultra vires doctrine and the Turquandrule.

The legislature considered it unwise to burden closecorporations with the accumulated learning on the ultravires doctrine and the doctrine of constructive notice. ThisAct, instead, in effect provides that these doctrines have noapplication and are not relevant to the question of whethera close corporation is bound by a particular contract madeon its behalf.

A company incorporated under the new Companies Actis a juristic person. Therefore all the common lawdoctrines applicable to the capacity and representation ofjuristic person will apply, except to the extent that the newCompanies Act provides to the contrary.

From section 19(4) and (5) of the new Companies Actit should be clear that the doctrine of constructive notice,although curtailed, has not been completely abolished. Infact, a person will be regarded as having received noticeand knowledge of any provision of a company’smemorandum of incorporation contemplated in section15(2)(b) if the company’s notice of incorporation or anotice of amendment has drawn attention to the provisionas contemplated in section 13(3), or of the effect of section19(3) on a personal liability company. To this extent thedoctrine of constructive notice will be applicable and stillremain relevant to the consideration of the legal position ofa company within this context.

Section 19(1) of the new Companies Act provides that acompany has all of the legal powers and capacity of anindividual, except to the extent that the company’smemorandum of incorporation provides otherwise. Thusthe powers and capacity of a company may be limited inthe company’s memorandum of incorporation and, to thisextent, the ultra vires doctrine finds application. Incontradistinction to close corporations law, the ultra viresdoctrine is thus not completely abolished, consequentlycomplicating the legal position of the company and thirdparties dealing with the company with the accumulatedlearning on this doctrine.

This seems to have been realised by the drafters, becauseit is sought to address some of the doctrine’sconsequences, reflecting to some extent the approachfollowed in section 36 of the present Companies Act. Interms of section 20(1) of the new Act, if a company’smemorandum of incorporation limits, restricts or qualifiesthe purposes, powers or activities of that company, noaction of the company is void by reason only that the actionwas prohibited by that limitation, restriction orqualification or as a consequence of that limitation,restriction or qualification, the directors had no authority

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Since its inception, the MTIC strategy has consisted of amulti-faceted approach combining both criminal and civilmeasures to tackle the fraud.

HMRC has maintained a successful prosecution policyfocusing on those that orchestrate the fraud. This approachsends out the message that such criminal activity will berobustly challenged, and with the high level of successfulprosecutions will offer a strong deterrent both now and inthe future.

However, criminal prosecution is not the answer toeverything and must be supplemented with civil strategiesthat tackle the economy of participation in fraud and deter

those that may consider that MTIC fraud may be aprofitable enterprise. With this in mind, HMRC has arange of interventions to mitigate the impact on taxreceipts where evidence of abuse can be demonstrated:

• denying input tax;

• denying the zero rating of intra communitytransactions;

• imposing financial penalties;

• taking action to recover lost revenue.

This approach has been refined and developed as a resultof case judgments emanating from the UK High Court andthe European Court of Justice (ECJ). So if there is such ablatant attack on the VAT system, why have not HMRC andother tax administrations found a permanent solution tothe problem?

LEGISLATIVE FRAMEWORKThe framework for the VAT system within the EU is set

out in EU Directive 2006/112EC, known as the “PrincipalVAT Directive.” This is a recast of the Sixth VAT Directiveof 1977, bringing together all amendments since 1977 inone single piece of legislation.

This legislation provides for a common system of VATwith a unified basis for assessment that respects theprinciples of proportionality, legal certainty and fiscal 9


Figure 1: MTIC carousel fraud

Figure 2: MTIC losses as published at PBR




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corporation to the dustbin of corporate law reform. Theyproclaimed: “End of the road for close corporations”,“Close corporations to be axed”, “The demise of the closecorporation”, “Death knell for close corporations”, “Theend of the close corporation.” The Department deemed itnecessary to issue a statement in February 2005categorically refuting “these rumours” and stating thatthere was no plan to compel close corporations to convertto private companies or lose their corporate status. TheDepartment was at pains to emphasise that although itspolicy document of June 2004 on South African CorporateLaw Reform stated “it is necessary to move away from thelargely artificial separation between the different businessforms, [and] to recognise only one formal businessvehicle”, this should not be interpreted to mean that closecorporations would have to convert to private or publiccompanies.

Notwithstanding the negative ambiance and pervasiveatmosphere of uncertainty, 519,634 close corporationswere registered during 2007 and 2008 compared to merely65,504 companies.

Eventually the Draft Companies Bill 2007 (the “Draft”)was circulated for comment. The Draft recognised varioustypes and categories of companies, ranging from “not forprofit” to “for profit” companies, and the latter from“closely held” to “widely held” companies, while all weresusceptible to the very strict “public interest company”regime. In 2007 the Corporate Laws Amendment Act 24of 2006 became operative. In addition to maintaining thepresent distinctions between companies limited by sharesand those limited by guarantee as well as between privateand public companies, it introduced a further distinctionnamely between a “widely held company” and a “limitedpurpose company.” Although the Amendment Act alsorefers to a “public interest company”, this term is notdefined.

Clause 226(1)(b) of the Draft made provision for therepeal of the Close Corporations Act. However, clause 2 ofSchedule 6 of the Draft stipulated that the President maynot bring clause 226(1)(b) into operation before a date atleast 10 years after the general effective date of the newCompanies Act; and the Minister has reported toParliament, no earlier than eight years after the generaleffective date of the new Act, on the utility of continuingthe dual system of incorporation under this Act and theClose Corporations Act, and the advisability at that time ofthe repeal of the Close Corporations Act.

Thus the Draft envisaged that close corporations wouldcontinue to co-exist for an interim period with the“closely-held company” after the new Companies Acteventually had come into operation. This is not to say thatthe Close Corporations Act would inevitably be repealed atthat stage. The Draft expressly created the possibility thatthe Close Corporations Act might continue in existenceindefinitely. It did not envisage a prohibition on the

formation of new close corporations during the interimperiod.

However, in the event this interim “in tandem”arrangement did not survive the reform process.

COMPANIES ACT 71 OF 2008

Introduction In reaction to comments received on the Draft, a much

revised Companies Bill was tabled in Parliament in 2008.It eventually reached the end of an arduous parliamentaryprocess as the Companies Bill 61D of 2008 and wasenacted in April 2009 as the Companies Act 71 of 2008(the “new Companies Act”). At the time of writing itsoperative date has not been determined by the President.

Categories and types of companies Abandoning the terminology “closely held company”,

“widely held company”, “public interest company” and“limited interest company” used in the Draft orintroduced into the present Companies Act by theCorporate Laws Amendment Act 24 of 2006, the newCompanies Act reverts to the traditional terms privatecompany and public company.

The new Companies Act provides for two categories ofcompanies, namely non-profit companies, the successor tothe current section 21 company, and profit companies. Thelatter may be one of the following types:

(i) Private companies, which are broadly comparable tocompanies of the same status under the presentCompanies Act;

(ii) personal liability companies, which are comparable tosection 53(b) companies under the presentCompanies Act;

(iii)public companies, which are comparable tocompanies of the same status under the presentCompanies Act; and

(iv)state-owned companies.

Interestingly, an important sub-species of company, thatmay be referred to for practical purpose as a “closely-held”or “exempted” company, is not dignified with a specificdesignation by the new Companies Act, although it israther obviously intended to compete directly with, or evenreplace, the close corporation.

For instance, in terms of section 30(2) of the newCompanies Act a private company in which a single personholds or has all of the beneficial interest in all the securitiesissued by the company, or in which every person who is aholder of or has a beneficial interest in the securities issuedby the company is also a director of the company, isexempted from the independent review of its annualfinancial statements. The exemption does not apply if thecompany has only one director, and that director is adisqualified person contemplated in section 69(12). 23



neutrality. Many tax administrations and professionals stillrefer to the articles of the Sixth VAT Directive.

Article 17 of the Sixth VAT Directive provides a taxableperson with the fundamental right to deduct input tax,therefore declaring to the tax authority that a commercialtransaction has taken place. This right to deduct must beexercised immediately in respect of all the VAT charged onthe cost components (see C-62/93 BP Supergas [1995]ECR I-1883, para 18, and joined cases C-118/98 to C-147/98 Gabalfrisa and Others [2000] ECR I-1577, para 43).

Tax administrations aim to ensure that the right amountof tax is paid by the right person at the right time. Abusiness must declare all the output tax due on its sales andthe input tax incurred on its supplies and pays the netamount to the tax authority.

It is reasonable that an honest taxable person is notliable if his supplier fails to pay over any tax charged and hisfundamental right to deduct any tax paid on his purchasesis unaffected. However, in organised criminal attacks onthe VAT system, such as MTIC fraud, the challenge for atax administration is how to tackle such abuse in aproportionate manner which penalises the non-compliantwithout penalising the honest taxpayer, or the requirementfor legal certainty.

HMRC’s approach to this challenge has been to exploreboth operational and legislative measures which focus on thethreat to the revenue whilst at the same time ensuring thatlegitimate businesses can operate on a level playing field.

IS TRADING IN CONTRIVED MTIC FRAUDSUPPLY CHAINS A REAL ECONOMICACTIVITY?

In May 2002 the UK began to deny input tax claimssubmitted by UK exporters on the basis that, where therewere circular supply chains, the goods were carouselledand did not conclude in sales to final consumers. There wasno commercial rationale behind the transactions, ergo noeconomic activity. HMRC argued that where the onlyintention was to commit fraud then such transactions didnot fall within the scope of the Sixth VAT Directive.

This approach was challenged by a number of brokerswhose input tax claims had been denied, eventuallyreaching the ECJ (see C-354/03, C-355/03 and C-484/03,Optigen Ltd, Fulcrum Electronics Ltd, and Bond House SystemsLtd v Commissioners of Customs and Excise [2006] ECR I-483).The question put to the ECJ was whether transactionsconstituting part of a fraudulent scheme set up by othersqualified as economic activities within the meaning ofArticle 4(2) of the Sixth Council Directive 77/388/EEC.

In its judgment of January 12, 2006 the ECJ found thattransactions within a fraudulent trade are within the scopeof the Directive:

“The right to deduct input tax of a taxable person whocarries out such transactions cannot be affected by the factthat in the chain of supply of which those transactions formpart another prior or subsequent transaction is tainted by aVAT fraud, without that taxable person knowing orhaving means of knowledge of the fraud” [emphasisadded].

The initial reaction of fraudsters was that this was adefeat for the UK and consequently, levels of fraudincreased dramatically (see figure 3). However, in giving itsjudgment the ECJ qualified it on the basis that thetaxpayer maintained a fundamental right to deduct so longas they did not know or did not have the means to knowthat they were involved in transactions linked to fraud.

HMRC recognised that if they were to deny the inputtax claims of those that facilitated and profited from thefraud then they would have to demonstrate that theclaimant knew or should have known that they weretrading in fraudulent supply chains. This came to be knownas the “knowledge test”. Such an approach is highlyeffective, albeit resource intensive, requiring thepainstaking collection and assessment of evidence tosupport a denial.

THE KNOWLEDGE TEST AND JOINT ANDSEVERAL LIABILITY

Whilst challenging the validity of input tax claims is animportant element of HMRC’s civil interventions, it is notthe only one. Consideration was also given as to how totackle the theft of VAT by the missing trader. HMRC hadalready gained enough evidence to show the contrivednature of transactions linked to fraud and the initial theftof the VAT by the missing trader. The question then aroseas to whether traders that knowingly and consistentlytraded with missing traders could be made jointly andseverally liable for any stolen VAT.

Joint and several liabilityIn the 2003 Finance Act, the UK introduced the

concept of joint and several liability into the VAT Act 1994(s 77A VATA 1994). The legislation focuses on what, at thetime, were the fraudsters’ preferred commodities, namelymobile phones and computer chips, and provides that abusiness can be made jointly and severally liable for stolenVAT if it had reasonable grounds to suspect that VAT wouldgo unpaid anywhere in its transaction chains.

Legal challengeAs with non-economic activity HMRC’s approach was

challenged in the courts, again being ultimately referred tothe ECJ. The appellant in this case was a group called theFederation of Technological Industries (FTI) (Case C-384/04, Federation of Technological Industries and Others[2006] ECR I-4191) which represented some of thebrokers submitting large VAT repayment claims. 10





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INTRODUCTIONThe purpose of the South African Close Corporations

Act 69 of 1984 (the “Act”) is the provision of a simple,deregulated, decriminalized, inexpensive and flexible free-standing limited liability vehicle for the single entrepreneuror small number of participants, to meet their reasonableneeds and expectations without the burden of legalrequirements that would not be meaningful in thecircumstances.

The total number of registrations, that is incorporationsof new close corporations and conversions from companiesto corporations, during the period 1985 to 2006amounted to 1,494,488 close corporations compared to387,757 companies of all kinds and types. During 2007and 2008 a further 519,634 close corporations and 65,504companies were incorporated. This puts the total for theperiod 1985 to 2008 at 2,014,122 close corporations and453,361 companies.

In this contribution attention will be given to the far-reaching if not drastic changes to be wrought by theprovisions of the Companies Act 71 of 2008 (the “newCompanies Act”) when it comes into operation.

SOUTH AFRICAN CLOSE CORPORATIONUnder the Act the South African close corporation is a

juristic person that confers on its members all the usualadvantages associated with legal personality and in which allor most members are more or less actively involved. Inprinciple there is no separation between ownership andcontrol. Every member is entitled to participate in themanagement of the business, to act as an agent for thecorporation, and owes a fiduciary duty and a duty of careto the corporation. The consent of all the members isrequired for the admission of a new member.

It is ideally suited to small businesses. The managerialand administrative requirements for close corporations areless formal than those for companies. The typical smallentrepreneur will be able to complete the constitutingdocumentation and register the corporation personally

without expensive professional advice. Although a closecorporation is required to have an accounting officer, aformal audit of financial statements is not required. Thereare no requirements for compulsory meetings, such asannual general meetings. Meetings are usually heldbetween members on an ad hoc basis. The members donot all have to take an active role in the running of thebusiness but are in principle entitled to do so.

The concept and development of the close corporationelicited international interest and even enthusiasticadmiration. A recent in-depth comparative studyemphasises the importance of the continued availability ofthe close corporation and its potential as a role model foran eventual societas africaea furthering socio-economicintegration within the context of SADEC and the AfricanUnion. It does not only serve as a highly significantindication of the importance of the preservation anddevelopment of such legal entities but also sounds as verytimely note of warning to South African law reformers toproceed with greater caution, circumspection and moredeliberation in this regard.

THE CORPORATE LAW REFORM PROCESSThe Department of Trade and Industry (the

“Department”) released its policy document on corporatelaw reform entitled South African Company Law for the 21st

Century – Guidelines for Corporate Law Reform for publiccomment on June 24, 2004. It suggested that only oneformal business vehicle should be recognised, whichshould be distinguished on the basis of size of turnover, andwhich would in turn determine the reportingrequirements. The policy document asserted that thecurrent distinction between close corporations, privatecompanies and public companies is artificial and does notallow an easy transition from one type to another.

Towards the end of 2004 newspaper reports suggestedthat close corporations would have to convert to privatecompanies to avoid losing their corporate status. Startingwith relatively low key and tentative statements, thesereports eventually explicitly consigned the close

The South African closecorporation under theCompanies Act of 2008by J J Henning


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In May 2006, the ECJ issued its findings supporting theUK’s approach to joint and several liability:

“Allowing a Member State to enact legislation, such as that inissue in the main proceedings, which provides that a taxableperson, to whom a supply of goods or services has been madeand who knew, or had reasonable grounds to suspect,that some or all of the value added tax payable in respect ofthat supply, or of any previous or subsequent supply, would gounpaid, may be made jointly and severally liable, with theperson who is liable, for the payment of tax” [emphasis added].

The ECJ made it clear that any national legislation suchas joint and several liability must comply with EU law inthat it must be applied in a manner which reflects thegravity of any abuse and must offer legal certainty:

“Such legislation must, however, comply with the generalprinciples of law which form part of the Community legalorder and which include, in particular, the principles of legalcertainty and proportionality” [emphasis added].

Both Bond House and FTI sent clear messages to taxadministrations that in tackling fraud they must take care toact proportionally and provide taxpayers with legal certainty.However, the ECJ also sent a clear message to knowingparticipants in fraudulent transaction chains that they couldnot benefit from the fraud by relying on EU VAT rules.

Kittel It is accepted practice that businesses must apply

corporate governance processes to protect themselvesfrom financial exposure. The extent of any corporategovernance is determined by the level of the risk.

The decisions in Bond House and FTI (joint and severalliability) reaffirmed HMRC’s expectation of appropriatecorporate governance, including due diligence/know yourcustomer/supplier checks, and proper risk management.This message was reinforced in a later ECJ decision in thecases of Kittel & Recolta, a co-joined Belgian casepublished in July 2006 (C-439/04 and C-440/04, Kittel vBelgian State and Belgian State v Recolta Recycling [2006] ECRI-6161). Kittel has become very much the model by whichtax administrations verify the veracity of input tax claimssuspected of being linked to fraud.

The case itself concerned a company called Computimewhich dealt in mobile phones and computer chips (MrKittel was the company receiver). Computime traded incomputer parts which the Belgian authorities discoveredwere part of an MTIC carousel fraud. As a result, theyconcluded that Computime had knowingly participated inMTIC carousel fraud and declared the contracts betweenComputime and their suppliers as void, effectively denyingtheir input tax claim.

The ECJ was asked whether, if a trader entered into acontract in good faith that was subsequently declared voidunder national legislation, EU legislation overrulednational legislation, therefore maintaining the taxpayer’s

entitlement to deduct input tax under Article 17 of theSixth VAT Directive. The court was also asked whether theanswer would be different if the contract was declared voidbecause of fraudulent evasion of VAT.

In its judgment the ECJ stated that so long as a taxpayerhad taken all reasonable steps, then they could rely onArticle 17 to recover their input tax:

“It is apparent that traders who take every precaution whichcould reasonably be required of them to ensure that theirtransactions are not connected with fraud, be it the fraudulentevasion of VAT or other fraud, must be able to rely on thelegality of those transactions without the risk of losing theirright to deduct the input VAT (see, to that effect, Case C-384/04, Federation of Technological Industries and Others[2006] ECR I-4191, para 33).”

The ECJ however qualified this in that no entitlementstood if the claimant themselves perpetrated fraud. Inthose circumstances the tax authorities could not only denyany input tax but could reclaim any input tax previouslypaid to the claimant:

“By contrast, the objective criteria which form the basis of theconcepts of supply of goods effected by a taxable person actingas such – and economic activity – are not met where tax isevaded by the taxable person himself (see Case C-255/02Halifax and Others [2006] ECR I- 1609, para 59).

“Where the tax authorities find that the right to deduct hasbeen exercised fraudulently, they are permitted to claimrepayment of the deducted sums retroactively (see, inter alia,Case 268/83 Rompelman [1985] ECR 655, para 24;Case C-110/94 INZO [1996] ECR I-857, para 24; andGabalfrisa and Others [2000] ECR I-1577, para 46).”

The ECJ in its judgment went on to state that anyonewho knew or should have known that they were trading infraudulent transaction chains would be regarded, for VATpurposes, as a participant in the fraud, regardless ofwhether they profited from the fraud or not:

“In the same way, a taxable person who knew or should haveknown that, by his purchase, he was taking part in atransaction connected with fraudulent evasion of VAT must,for the purposes of the Sixth Directive, be regarded as aparticipant in that fraud, irrespective of whether or not heprofited by the resale of the goods.

“That is because in such a situation the taxable personaids the perpetrators of the fraud and becomes theiraccomplice. In addition, such an interpretation, by makingit more difficult to carry out fraudulent transactions, is aptto prevent them. As the court has already observed,preventing tax evasion, avoidance and abuse is an objectiverecognised and encouraged by the Sixth Directive (seeJoined Cases C-487/01 and C-7/02 Gemeente Leusdenand Holin Groep BV [2004] ECR I-5337, para 76).

“Community law cannot be relied on for abusive orfraudulent ends (see, inter alia, Case C-367/96 Kefalas




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(again, independent of the Code Civil, and having its own“supreme court,” the Conseil d’Etat), plus, of course,déontologie. The subject of my four-hour paper in criminallaw turned out not to be any of the traditional, classicalareas (crimes against the person, against property, againstthe state or against humanity), but “the criminal liabilityrisks of corporations”!

I passed. Then, in completing the paper work foradmission as an avocat à la cour (Paris), I was told that mycontrat de collaboration with my colleagues in chambers hadto be revised to state a minimum monthly salary! (Thismay be justified to prevent young associates from fallinginto slavery, but it again smacked of an unrecognizedcommercialism in a profession officially opposing filthylucre as having anything to do with its nature). But, all ofthis having been finally resolved, I took the oath to becomean avocat in an impressive ceremony in the First Chamberof the Palais de Justice’s Court of Appeal – where the trial

of Pétain had been held following the liberation of Parisand the defeat of the Nazis.

Was it worth it? Of course. But never think thatlawyers are lacking in old fashioned territorialism – evenwhen it goes against there own principles. The oath of theavocat pledges him or her not only to “dignity,”“conscientiousness,” “independence,” and “honesty” –but also to “humanity.” Surely “humanity” shouldembrace greater appreciation of the high legal standards ofour European states in general, as well as (why not?) therecognition that a lawyer can be a fine practitioner even ifhe is not well remunerated for it.

John Warwick Montgomery

Professor Emeritus of Law and Humanities, University of Bedfordshire;

Distinguished Professor, Patrick Henry College (Virginia, USA).


and Others [1998] ECR I-2843, para 20; Case C-373/97 Diamantis [2000] ECR I-1705, para 33; andCase C-32/03 FiniH [2005] ECR I -1599, para 32).”

The ECJ stated that the decision to deny input taxrecovery lies squarely with the national administration:

“It is a matter for the national court to refuse to allow theright to deduct where it is established, on the basis of objectiveevidence, that that right is being relied on for fraudulent ends(see FiniH, para 34).”

Kittel had built on the abuse argument first examined inthe Bond House judgment and echoed in FTI, clearly statingwhat the taxpayer could expect with regard to legalcertainty and proportionality from their respective taxadministrations. However, it set out the parameters underwhich taxpayers may rely on the VAT Directive to protectthem. The knowledge test has been used extensively in theUK and across the EU and has become an important partof the EU’s efforts to combat MTIC fraud.

IS FOCUSING ON BEHAVIOUR THE ONLYOPTION?

The measures in this article so far have focused on thebehaviours of those perpetrating, profiting from orfacilitating the fraud. However, HMRC has also lookedacross the piece at other means by which the fraud canbe tackled. In 2007, HMRC introduced legislationwhich focused on the mechanism by which VAT could bestolen.

Any change to the general rules of the VAT system is notto be taken lightly. Member States considering such actionhave to obtain a derogation from EU law supported by all26 fellow Member States. On June 1, 2007, havingsecured a derogation, the UK introduced a domesticreverse charge in respect of wholesale trade in computerchips and mobile phones.

So what is a reverse charge, and why mobile phones andcomputer chips?

A reverse charge transfers the obligation to pay outputtax from the supplier to the customer but the customerretains its entitlement to deduct VAT on its purchases. Thismeans that in effect at each stage a business is in a net niltax situation and the opportunity to commit MTIC fraud isremoved. A reverse charge only applies to business tobusiness transactions and the normal accounting rulesapply on sales to final consumers. As a consequence it is nolonger possible for:

• the missing trader to disappear with the VAT paid tohim by his customer but owed to HMRC;

• traders to divert the VAT due to be paid by theirsuppliers through third-party payments; and

• the exporter to claim a VAT repayment from HMRC.

These commodities were chosen because they were thegoods most commonly used in UK carousel fraud supplychains. The effect of this legislative change has been to stopMTIC carousel fraud in mobile phones and computerchips. The reverse charge and the application of theknowledge test to tackle all MTIC style trade maintains adownward pressure on MTIC fraud and revenue losses.

You may ask why, if the reverse charge is so effective,HMRC does not apply it to all goods. The answer is that itis only appropriate in specific circumstances. Under thefractionated collection system VAT is collected on the valueadded at each stage in the supply chain, mitigating theimpact of fraud at the point of sale to the final consumer.For all its imperfections the VAT system is generally a muchmore effective system for collection of revenue than asales/purchase tax levied at the retail stage. 12


Figure 3: The changes in levels of fraud in reaction to legislative developments




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the European Directive with a local language requirement(French, German, and Luxembourgish!), the EuropeanCourt of Justice ruled that this was contrary to the spirit ofthe free establishment of European workers and against theclear intent of the Directive (decision of September 19,2006).

But a non-French EU lawyer, even when he or shesuccessfully enters into such an arrangement, is veryobviously a second-class citizen. He or she must pay thefull fees to the Bar that a French avocat pays and must fulfilthe same annual continuing legal education requirementsthat apply to the French avocet – but one’s name appears insmall letters in a separate section of the Tableau des Avocats(the official regional listing) or in minuscule type in theParis Bar directory.

And if the non-French lawyer wishes to become a full-fledged avocat? Here, two paths exist. The one appearssimple and non-threatening: three years of practice inFrance, and no examinations! This possibility, to be sure,came about not through any French efforts (quite to thecontrary) but by way of a European Directive of February16, 1998 – which did not get transposed into French lawuntil February 11, 2004! (It now comprises Articles 89and 90 of the revised Law of December 31, 1971). Theproblem with this alternative is that the three years ofrequired full-time practice need to be in “French law.”But, being a foreign attorney, the non-French lawyer is notsupposed to be practising French law! The text goes on tosay that if there is insufficient evidence of such practice, theBar to which he or she applies has the right to “evaluate theregular and effective character of the activity exercised, aswell as the capacity of the candidate to pursue such.” This,of course, leaves open a wide area of discretion to the localBar – even though, technically, the burden of proof inrejecting the candidate falls on the Bar, not on theapplicant.

The second route for the non-French EU lawyer tobecome an avocat is to pass “Article 99” examinations.These are set individually for each applicant, and canconsist of up to four tests, depending on how closely thecandidate’s legal education and experience parallel theFrench model. One examination is always on the practiceand ethics of the profession (déontologie). The others arespecified from a list derived from the CAPA requirements;civil law is a standard – plus commercial law, administrativelaw, criminal law, and employment law. If four subjects areassigned, one of them (chosen by the National Council ofthe Bar, which sets the list for each candidate) must consistof a four-hour written examination. The other subjects aretested by oral examination before juries. Two examinationperiods maximum are now set each year, one in Paris, theother in Versailles; in Paris, the jury consists of threeexaminers (a law professor who is a specialist in the givensubject, a former member of the Bar Council, and apractitioner), whereas Versailles employs five-memberjuries.

If the European lawyer comes from a Napoleonic Codejurisdiction (say, Italy) or from a strongly French-speakingarea (say, Belgium), he/she may be required only to do anoral in one or two subjects (déontologie is alwaysmandatory). But all UK lawyers (solicitors, barristers,Scottish advocates), being from common-law backgrounds– after all, even the civil-law Scots end up before thecommon-law Supreme Court of the United Kingdom – arerequired to do the maximum of four subjects, and thismeans at least the one four-hour written examination plusthree oral examinations. The style of these examinations isnot the “practical, problem-solving” style of the Article100 examinations, but the academic, essay style of theFrench university curriculum, where, for example, in thelegal area, one always divides one’s answer into two majorsubsections! To pass, one must average 10 out of 20 in toto,and one can only sit for the examination three times.

And now, a personal word. After two years as a memberof the Strasbourg Bar and three years a member of the ParisBar – both under my foreign practising title of barrister-at-law (England and Wales) – I applied to take the oath as aFrench avocat. My dossier was replete with evidence of mylegal activity in France, chiefly in the area of my specialty,religious liberty litigation before the European Court ofHuman Rights in Strasbourg. I was informed that this wasinadequate. Why? Because I could not show that myincome derived principally from this practice. Of course itdid not: I am a university professor and my legal work hasbeen largely pro bono. I pointed out, using an article on theParis Bar’s own website, that historically the French Barhas valued unremunerated service in behalf of the poor anddowntrodden. Indeed, the French Bar grew out ofeleemosynary service by lawyers who were clergy. “Woulda physician be less good a doctor if he treated patients forfree?” I asked. I also reminded the powers-that-be thatone of the differences between French lawyers and Anglo-American lawyers is that the French avocat must not engagein any form of commercial activity. Indeed, an avocatcannot simultaneously be a member of any otherprofession (medicine, accountancy, etc) – with theexception of university teaching or a religious ministry. (Afew years ago, in 2003, a young avocate was suspended forhaving played an accordion for money on a public street –though this was reversed on appeal. My arguments were tono avail. I withdrew my application and determined totake the tougher route.

I was therefore left with the Article 99 examinations. Inspite of my possessing four earned law degrees, includingthe LLD – the higher doctorate in law – from CardiffUniversity, the National Council of French Bars requiredme to pass the maximum of four examinations. Their onlyconcession, on the basis of my practice in France, was tosubstitute criminal law for civil law as the four-hour writtenexamination. The oral examinations required of me werein commercial law (with its independent Code de Commerceand separate commercial courts), administrative law20



SUMMARYThe article has shown how levels of fraud changed in

response to decisions by the courts or legislative changesintroduced by HMRC. The impact on receipts can beconsiderable if not tackled at the earliest opportunity.

The UK has carefully analysed every element of thefraud and sought ways to tackle the fraud at specific points.This approach has enabled HMRC to demonstrateconsiderable success in reducing levels of fraud andultimately the levels of losses.

The role of the courts has been a major factor not onlyin the approach of tax administrations but also in thetactics adopted by MTIC fraudsters. The courts haveindicated that any action taken by a tax administration

must be proportionate and offer the taxpayer legalcertainty. However, taxpayers must also bear responsibilityfor losses if they do not take appropriate care and chooseto turn a blind eye for the sake of profit.

No single measure will solve the problem of MTICfraud, but having a combination of carefully plannedmeasures in place, backed up with the continuingmonitoring of risk, will keep levels of fraud to aminimum.

Steven Pope and Roderick Stone

HM Revenue & Customs.

13





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