If you are a director of a company which has entered into any type of aggressive tax scheme and your business is now struggling, you really need to read this.
This is why…
In late 2016, Implement Consulting Limited went into insolvent liquidation, its statement of affairs showing there to be no assets and one major creditor, HMRC, for over £1m. Later on down the line, they lodged a proof of debt in the liquidation for £1.75m. On face value, with no ostensible assets, things looked hopeless for HMRC.
But liquidators have a duty to investigate the affairs of companies to ascertain if action can be taken against directors, others associated with the company and third parties in order to generate cash to pay to creditors. And they have the power to look back in time at transactions that occurred some years before a company’s demise. Often, if there are no money or assets in the liquidation pot to finance any legal action, directors can get away with it, this is one time when they didn’t….
You see the company had paid around a couple of million pounds into two tax schemes, an Employment Benefit Trust and an Interest In Possession Fund, between 2009 and 2013, the majority, but not all, of which went to the company’s directors.
The liquidator challenged the payments on the basis they were:
- Distributions out of profits, for which the proper procedures had not been followed, making them illegal.
- Transactions defrauding creditors attackable under s423 of the Insolvency Act because the directors must have been aware there was a risk that HMRC would attack the schemes and paying out the money from the company without having made proper provision for a potential claim from HMRC meant they were putting assets beyond the reach of creditors / potential creditors. (S423 enables the liquidator to upset any transaction that puts assets beyond the reach of creditors however far back before liquidation it may have occurred).
What was decided?
The judges decided that:
- The money paid into the two schemes were effectively distributions and illegal as proper provision had not been made for HMRC’s potential debt, and was thus repayable by the directors by reason of a breach of their duties.
- The directors failed to take proper legal advice or read properly the warnings of the seller of the schemes, failed to get any comfort from HMRC before entering into the schemes, and so took a risk they did not understand. This means the directors failed in their statutory obligations to the Company.
The directors should therefore pay over about £3.5m to the Liquidator.
So what?
There are three main implications:
- Directors need to be very mindful of their duties when considering going into any form of tax saving scheme in a company as their decision can come back to bite them years down the line should the company go into liquidation.
- If you should be exploring putting your company into liquidation or administration, whether the company previously had a tax scheme in place must form part of the liquidate / not decision, with the alternative of say CVA worthy of consideration. Why? – because Supervisors of CVAs do not have the power to upset such transactions (but note, the potential for such an action should be reported in the CVA Proposal so creditors can properly assess the liquidation/CVA option when voting). This case could severely limit directors’ options.
- If you are an accountant or other advisor to a company that is contemplating entering into such a scheme, you really need to bring this case, and the potential for the directors to be attacked personally, to the attention of your client.
Other points to note…
HMRC declined to fund the legal action in this case, even though the sums involved, and therefore their potential recovery, are quite large. The liquidator found other ways to finance the action, at a cost of about £0.5m. With a precedent set, other IPs might find it easier to get HMRC to finance them or to secure third party finance. This case has not yet widely come to the attention of the insolvency profession, but going forward you can expect more litigation both as regards existing and coming insolvency cases where there are similar circumstances / facts.
It’s really worthwhile reading the full judgement if you’re advising a client with similar circumstances – Click here to read the judgement.