Is there a storm coming your way?
The Background
You may have heard about something called the Loan Charge? It’s led to big tax calls on companies and the individuals who benefitted from such loans. In fact HMRC estimated they’d collect £3 billion, three quarters of which from companies, the rest from individuals, for the charge. So far HMRC have collected over £1 billion.
In December 2019 a paper called the ‘Independent Loan Charge Review’ (‘the ILCR’) was published by a lord of the realm – click here to go to the review. The review was the government’s response to criticism levied at HMRC’s Loan Charge.
If you could be subject to a loan charge it’s worthwhile reading the executive summary of the report, pages 3-8, and recommendations pages 9-12.
So how did this all arise?
It is believed that around 100,000 companies have used a particular type of ‘Employee Benefit Trust’ (‘EBT’) as a ‘tax saving scheme’ promoted by accountants and others.
A company would pay employees’ gross remuneration into the EBT which then ‘loaned’ the same amount on to the employee, without charging interest, with repayment only to be made when demanded – there were no regular repayment obligations as a normal loan would have . However, in practice, that repayment was never demanded, the loan simply got bigger, in one recent case I saw half a million pounds from one director.
The scheme enabled the company to avoid Employer’s NIC and the employee to receive their remuneration gross, without deduction of either Income Tax or Employee’s NIC. Payments to and from this type of EBTs were according to the author of the ILCR nothing more than ‘disguised remuneration’ / tax avoidance, and quite commonplace. Note that while tax evasion is illegal, tax avoidance isn’t.
So what’s the Loan Charge?
The Disguised Remuneration Loan Charge (the “Loan Charge”) was introduced by the government in the Finance Act 2019, and enabled HMRC to purse both the company and the individuals who benefited from such an EBT, giving HMRC the ability to seek the payment of the Income tax and NIC that would have been due had the money instead been paid as Schedule E remuneration.
In the event that the company is in a formal insolvency process such a liquidation or administration, or simply cannot pay, responsibility for paying the Loan Charge passes to the individual who benefitted. This was often a director or shareholder of the company – who could have had a choice as to whether to go into the scheme – but it could also be an employee, someone who simply had little choice. The individual was required to report how much they owed to HMRC before 5 April 2019, HMRC would then agree both the amount and a repayment plan.
In late January 2020, HMRC responded to the ILCR, giving some guidance on how they will be dealing with the loan charge going forward – click here to go to that guidance, it’s quite long and I’m not a tax practitioner so I will leave it to you to read!
Who’s effected by this?
The individuals effected include employed and self-employed individual contractors (yes, they’re really under the cosh at the moment), small businesses with a few staff, right up to highly paid directors seeking to avoid paying large sums of tax and NIC in their own company.
But directors of companies that went into an EBT, either as the ‘employer’ or ‘beneficiary’, are particularly exposed …
Why is that?
It is because as directors they owe a number of fiduciary and statutory duties to the company, including to act in its best interests, and when a company is insolvent, or near insolvent, additional duties kick in. Where the directors’ actions are found wanting, and they cause loss to the company, then an insolvency practitioner of the company can bring proceedings directly against them for misfeasance, often a good number of years after the event. And IPs are, and going forward will continue to be, actively looking for instances where the sole, or major, beneficiaries of such a disguised remuneration scheme are the director(s) or their families/associates.
But here’s the rub… they will also be looking for and taking action against directors where others not just the directors, benefit from such a scheme and the scheme was considered to be quite verging on evasion or put the company’s financial position in jeopardy, making the payment of dividends illegal, albeit with the benefit of hindsight.
Read my blog on one such recent legal action taken by an IP by clicking here.
And misfeasance is not the only claim an insolvency practitioner can bring where there was an EBT – action can be taken for a ‘transaction at an undervalue’ or a ‘transaction defrauding creditors’. And transactions defrauding creditors can be attacked however long ago they happened.
IPs are only now waking up to consider whether there could be a misfeasance or other claim taken against the directors where there was an EBT – although that legal case is recent, it provided clarification on what is old law, the law that applied to the case they are dealing with at the time the transaction happened. It has really ruffled a few feathers. And because IPs have a duty to act in the best interests of the creditors as a whole, not you as director or shareholder or your employees, if you’re a director of a company that’s already in liquidation / administration which had an EBT, you can expect the IP to be dusting off his files. If the IP doesn’t consider this, then they would be putting their own career and family are at risk – because their governing body can take away their livelihood. So you can expect no favours.
So what’s the interaction between insolvency claims and the Loan Charge?
HMRC say they will not enter into direct agreements with individuals where the company is already in a formal insolvency process (such as liquidation or administration) without including the IP in the negotiations. However, HMRC have said this does not apply if the individual has approached them direct to try to reach a settlement. Such a direct settlement with HMRC will not enable a director to avoid an IP’s misfeasance claim.
So if you are a director of a company that went into an EBT, you could find yourself negotiating with both the IP and HMRC. Messy.
Conclusions
- Recent case law has shown that directors might have breached their duties, and thus be personally liable to pay money into the company, if they acted recklessly by allowing the company to enter into a tax avoidance scheme. Neither the review nor HMRC’s response on the loan charge impact on IPs’ claims against directors of insolvent businesses – pre-existing claims continue, fresh claims can be taken against directors notwithstanding what HMRC do. The fact that you might be negotiating with HMRC doesn’t stop an IP taking action against you at the same time.
- If you’re a director of a company that has entered into an EBT at any time (even if you did not benefit yourself):
- And the company is already in either liquidation or administration, you could soon find yourself the subject of legal action taken by your existing IP, yes even now, long after you thought the liquidation was virtually finished. If you do, seek legal advice from an experienced insolvency lawyer. If you want me to recommend one, call me.
- And the company is now insolvent, you should consider in your assessment of your options the potential for an IP to make what could be a very large claim against you should you take the liquidation or administration route. The risk of such personal liability for money you might not have had or might have spent could cause a change of mid as to the formal insolvency process you choose – for example, is CVA a better option? – or it may make any formal insolvency process so unattractive that you might be forced instead to refinance the company instead, even if you have to do it personally.
Choppy waters ahead…