Hello and welcome back after a little holiday break to the Pinsent Masons podcast, where we hope to keep you abreast of the most important developments in global business law every fortnight. I'm Matthew Magee and I'm a journalist here at Pinsent Masons and this week we hear about a big change in companies' liability for fraud in the UK and find out why organisations with lots of group companies need to be careful about VAT after a UK Supreme Court ruling.
But first, here's some business law news from around the world.
Alternative investment fund managers face Rulebook update in Ireland.
FCA says AI providers could face UK financial services regulation and
UN sanctions on Iran are set to be reinstated
Ireland is likely to grow in popularity as a market for alternative lenders if rule changes proposed by the Central Bank of Ireland are implemented, an expert has said. Conor Durkin was commenting after the CBI opened a consultation on a series of proposals to amend its rulebook for alternative investment funds, or AIFs. One aspect of the proposals concerns loan-originating funds, a form of AIF that's become a source of private credit for a growing number of businesses across Europe in recent years. To reflect changes to EU rules, the CBI has set out plans to remove its domestic framework on loan origination funds. This would eliminate any gold-plating of the EU rules that apply to those funds in Ireland. Durkin said the proposed removal of the loan origination chapter is very positive. It means that managers of Irish loan origination AIFs will have greater flexibility in relation to borrower types and asset exposures.
AI providers could be directly subject to UK financial services regulation in the future, says the regulator. In a new AI update, UK financial services regulator the Financial Conduct Authority confirmed that AI providers could be designated as critical third parties, or CTPs, in the future, depending on how the use of AI in UK financial services evolves. AI providers designated as CTPs could come within scope of further regulation, it said. The financial sector is increasingly reliant on outsourced technology and third-party service providers, and the Bank of England Prudential Regulation Authority and the FCA have moved to introduce rules to try and ensure sector stability and operational resilience. Financial services technology expert Luke Scanlon said that providers of AI models are facing increased scrutiny and compliance obligations. He said more guidance from policymakers and regulators on navigating overlapping requirements would be helpful in that scenario to assist AI providers in operating in an increasingly complex regulatory environment.
Businesses and assets with links to Iran could be affected if UN sanctions on Iran are reinstated, a sanctions expert has said. Stacy Keen commented after France, Germany and the UK initiated a process that could lead to the reinstatement of UN sanctions that previously applied to Iran. UN sanctions on Iran were lifted in 2016 after the country signed a plan of action in tandem with the US, China, Russia, UK, France, Germany and the EU under which it committed to a series of actions limiting its nuclear and weapons programmes. France, Germany and the UK said they would trigger a so-called snapback process which will reimpose UN sanctions on Iran if it significantly violates the terms of the previous agreement. The triggering of the snapback process means the UN Security Council has until the 27th of September to pass a fresh resolution to continue providing UN sanctions relief to Iran, failing which the previously imposed sanctions will be reinstated.
Two weeks ago, a major new law came into force in the UK introducing for large companies an offence of failing to prevent fraud. The Economic Crime and Corporate Transparency Act, or ECCTA, is a big change and is designed to make it easier to hold companies to account for fraud. Forensic accountancy specialist David Lister told me about the changes.
David Lister: So I think there's two things that clients need to really think about. The first is the change and the introduction of a failure to prevent fraud offence. So if clients have worked through the Bribery Act back in 2010 or are aware of that, it's basically the Bribery Act, but in relation to fraud. So a failure, a criminal offence of failing to prevent fraud by an associated person and all of the things that come with that in terms of risk.
The second key thing is the lowering of the corporate criminal attribution test and the lowering of that from the directing mind and will of the company to the fraudulent conduct of senior managers. So that ability for the authorities to hold companies criminally liable has increased and that has a big impact on both the actions of individuals in corporates, but also the consequences of wrongdoing and the size and scale of investigations that might flow from those.
The new changes to the corporate criminal attribution test mean that whereas before it was very difficult to hold a company criminally liable, it's going to be easier now because the test of what that means is lowered. So it used to be the directing mind and will of the organisation, which effectively meant very senior C-Suite board members acting in concert. Now it's lowered the bar down to the actions of senior managers and senior managers defining the legislation quite widely so more people can create the ability for the corporates to be prosecuted.
Matthew Magee: New guidance has been published for prosecuting authorities, telling them how to interpret the new law when deciding who to prosecute and when. David says it's essential reading for companies.
David: There's probably two sets of guidance that are really important. The first set was issued back last year by the Home Office, which provided guidance to companies on how to avail themselves of the reasonable procedures defence. So whilst the legislation brings in an offence of failing to prevent fraud, it also brought in an ability to demonstrate reasonable procedures and therefore mitigate that offence. That guidance is worth reading for anyone who's sort of tasked with assessing the impact of a vector on their company. More recently, guidance was issued by the CPS and that basically explains to prosecutors and helps them embed the new changes from ECCTA into their decisions around prosecution. The easiest way to outline it is a quote. This was part of the press releases and by virtue of Section 196, prosecutors no longer need to establish that the individual was the directing mind and will of the company. It's sufficient to show that the individual was a senior manager acting within the actual or apparent scope of their authority. You can see that law enforcement prosecutors are being told the bar is lowered and they need to factor that into their decisions around whether to bring these offences forwards.
Matthew: So this is a major change for companies and for senior managers and directors within them. So how have they been preparing for it and how should they treat this issue in the future?
David: Most clients have been doing a combination of two things. They've been assessing what they have in place compared to what's required to meet the standards of the legislation, so that current state assessment, if you like. Then they've been undertaking a risk assessment around ECCTA fraud, assessing where their organisation may have risk. That's different from the existing fraud risk assessments they may have done. Typically, organisations' current plans have looked at fraud on the organisation. ECCTA, when you read the legislation, is really focused on fraud by the organisation, so what the organisation is doing that may perpetrate a fraud on other people. It's a great first start. But if you've assessed the current state and it's found wanting, then there are things you need to do to change. There is a programme of change, and if your risk assessment identifies a risk that currently isn't managed or mitigated, then you need to do things to manage that risk. The guidance was helpful in regard to this because it recognised that for large corporate entities you can't just change your compliance programmes overnight. We'd expect that process may take time, but obviously the longer you leave a risk unmanaged, the further away you get from the 1st of September, the heightened risk that you have an offence and you're not managing it properly.
Matthew: Companies have already gone through something similar when a failure to prevent bribery was introduced in the UK a few years ago, and prosecutions based on that law are now happening. But David said that this is a bigger change because fraud is a bigger problem than bribery.
David: The genesis of the legislation was about managing large-scale corporate failures where stakeholders, shareholders, pension holders lose out. As with all these cases, it captures a much wider range of fraud typologies. One way to give a sense of it is when the Bribery Act came in, that was a seismic shift for compliance and corporate entities. We at Pinsent Masons, for every one bribery investigation that we're helping clients investigate, we've probably done five to eight fraud investigations. So the number of fraud issues is much, much higher. I think it's going to become much more of a day-to-day issue for companies to wrangle with and wrestle with. The legislation is aimed at strengthening the powers of law enforcement to prosecute companies for the wrongdoing of associated persons so the company is the target of this legislation, but law enforcement have been quite clear and it's in the recent guidance that whilst the prosecution of corporate entities is important to set a tone and manage criminality, they still expect that it shouldn't be a substitute for prosecuting individuals criminally, so directors, senior managers, officers, employees, etc. What the legislation really does is say you could always prosecute the individual. The hard thing was to prosecute the corporate. This now makes that easier, and what their guidance to prosecutors is saying is don't use this as a substitute for still prosecuting the individuals. They expect it to be in tandem.
Matthew: ECCTA is the latest piece of legislation to govern some fundamental parts of companies' behaviour and compliance or legal teams might find the scale and speed of change a bit overwhelming. But David says that companies should move away from thinking about compliance with each individual law in isolation and consider the wider picture and the whole corporate culture.
David: This isn't a one-part-of-the-organisation exercise. It needs finance, legal, risk, compliance to come together and assess what they've got in place and whether it meets the requirements of ECCTA. What we're seeing is building tools to help manage the risk, but not necessarily building big teams of people that just look at fraud. Fraud is across the organisation and therefore different parts of the organisation can take ownership and accountability for elements of the risk. The second trend that is really important to think about is with the Bribery Act, failure to prevent facilitation of tax evasion, now the failure to prevent fraud, these types of legislation are happening and going to continue to happen. So actually, rather than going to the organisation in slices around individual bits of legislation, we're seeing a lot of companies, and working with a lot of clients, to think about how do we bring this together under an umbrella of financial crime and therefore better manage the risk without having quite as big an impact on the company. Because you can imagine going to business units every six months saying we need to do a risk assessment for this and we need to do this for that, that just sort of is a challenge in busy organisations. So streamlining that under a banner of financial crime and reshaping in that way, I think, is probably a trajectory.
The UK's highest court, the Supreme Court, has ruled in a case about how companies in the same group deal with VAT. VAT expert Bryn Reynolds says that though the ruling is about some quite unusual circumstances, it should prompt a bit of a rethink for organisations where companies might come in and out of a group structure, such as when one is bought or sold. The case covered pretty niche territory, whether VAT group rules or rules about the time that goods and services are supplied should take precedence when it comes to calculating VAT. But Supreme Court rulings are so powerful and binding that the business world takes notice when one is made. So first I asked Bryn to explain how intra-group contracts deal with VAT and how that interacts with time of supply rules.
Bryn Reynolds: So for VAT, we have this odd legal fiction whereby we say that if you have a number of entities all with the same ultimate ownership and you apply to do so, you can have them as part of a VAT group and the legal fiction we then have is that that VAT group is treated as one single entity. So despite it being one single entity from a VAT perspective, you still have services going to and from each of the different parties and so you then have these intergroup contracts where if one party is supplying services to another, then that's an intergroup contract. Now, one of the difficulties you have with intergroup contracts is that because each of those entities and the supplies between them aren't treated as supply for VAT purposes, there's no VAT on them typically, you then don't necessarily always have the same rigour that you would normally have in terms of the VAT clauses between those companies because when it goes to the VAT team, the temptation is to say, well, it's all within the VAT group, so there's not a problem here.
So we have this legal fiction whereby we treat all of the different companies all as a single legal entity. This case, however, concerns both that and another legal fiction we have, which is around the time of supply rules, which says that even if you're actually supplying services at this time, we have another fiction we overlay on it which says those were only supplied at certain times, particularly in the case of, as is here, continuous supplies of services. And this case has clarified a couple of points in relation to that, but what had never really been fully tackled by the courts was how the interaction of these time of supply regulations happened together with our other legal fiction of VAT grouping.
Matthew: In this case, the supply of services was between insurance company Prudential and a company that was part of it and was then sold to someone else.
Bryn: So in this case, a member of the VAT group known as Silver Fleet had been supplying investment management services to Prudential within the VAT group for many, many years. All these services were treated as a nullity for VAT purposes because they all happened within the VAT group and so no one had particularly looked at the treatment of these services. There was a particular arrangement whereby a substantial contingent fee would become payable at a much later date depending upon the performance of the investment portfolio. At some point Silver Fleet was sold off and therefore left the VAT group because it would no longer be eligible to be part of that VAT group. At this stage the services were all terminated. So the services were finished by the time it left the VAT group. Many years later, the conditions for that conditional payment were met and what that then meant was that the payment was then made by Prudential back to Silver Fleet. Now the question was, were those services actually performed when it was part of the VAT group and so therefore there was no VAT on that payment, or were they performed at the much later date at which under the time of supply regulations, the services would be considered performed at the date when the payment was actually made and it was a substantial sum of VAT. Prudential, in receiving these services, didn't think they should be subject to VAT, but HMRC thought that VAT should be charged by Silver Fleet because the actual time of supply, based on time of supply regulations, would be the much later date after it had left the VAT group.
Matthew: The court made a very clear ruling that the time of supply rules take precedence, but says Bryn had to be careful not to open up new ways for companies to try and avoid the payment of VAT.
Bryn: Now, the oddity here is that things were happening whilst they were potentially within the VAT group when the services were actually performed. Now, that then means: do you look at the VAT time of supply rules, or do you use some other, as the Court of Appeal previously referred to it, meta rules going over the top of all of these, where you try and assess exactly when it's actually performed and the position they've got to previously in the case of BJ Rice, the previous Court of Appeal case, the position was that what you had to do was apply the VAT time of supply rules only once you're within the VAT regime. What we now have here is fairly definitive evidence from the Supreme Court, although they have still left open in a number of different situations what you need to do and from that perspective, it's always apply the VAT time of supply rules first of all, and only then do you look at other criteria such as VAT grouping or the registration situation. One of the confusing pieces here, as they try to thread their way through to an answer, is that the time of supply rules have been used to try and create a number of different VAT avoidance scenarios by delaying or accelerating payment scenarios in order to manipulate the tax point. What they've tried to do quite carefully in the judgement is spread through so that they're not providing a max mischief for a taxpayer to go and say, “Actually, the Supreme Court has said this in this decision and therefore the time of supply rules always take precedence.” What they've instead said is they've quite deliberately reserved their judgement on a number of those scenarios to those actual fact patterns, rather than overruling previous cases where they have determined that actually a different scenario would happen.
Matthew: While not that many companies will be caught in the exact same situation as Prudential and Silver Fleet. The ruling still has some pretty big implications for lots of companies, says Bryn.
Bryn: I think that anyone within a VAT group or potentially companies entering a VAT group, there's going to need to be much more clarity in terms of the VAT clauses and how those operate, both on a general basis, but also when the company leaves the VAT group. So I think there's going to be a lot more scrutiny from the VAT team and the legal teams in terms of analysing those contracts and making sure that everyone is agreed not just on what happens right now when the company's within the VAT group, but also what would happen when the company later left the VAT group. In a mergers and acquisitions context, anytime there's a company that's going to be leaving the VAT group, there will need to be careful consideration around any additional payments that may be due at a later date and how those will interact with the final accounts. Companies need to be thinking around when they're entering into contracts what the VAT treatment is. It doesn't matter if at the moment it's within a VAT group. Ultimately, it might go out of the VAT group, and so much more care and attention needs to be paid to the proper treatment of VAT in those contracts and just starting with the basics of whether the payment is VAT exclusive or VAT inclusive. It wasn't a factor here. But in many other scenarios, just having that clearly in the contract, even if it's not relevant at the time, you need to be future planning and working through any other scenarios where it could later become relevant.
Thanks once again for joining us on the Pinsent Masons Podcast. Please do like, review, and most importantly, share it with anybody else who you think would be interested in discussions of legal and regulatory changes across the whole world of business. And remember, you don't just have to listen to me. You can read our stories every single day at pinsentmasons.com or you can sign up for a personalised weekly update at pinsentmasons.com/newsletter.
Thanks for your time today. It's always appreciated. And till next time, goodbye.
The Pinsent Masons Podcast was produced and presented by Matthew Magee for international professional services firm Pinsent Masons.
