Frances Coulson
- Partner
- Insolvency & Restructuring
HSJ Consultancy Limited
There is a quote from Proverbs 15:22 which is the key takeaway from this case. The verse states, “Without counsel, plans go awry, but in the multitude of counsellors they are established“. Company directors should always seek independent advice when considering any tax planning arrangements to incentivise employees or remunerate key individuals, especially if that planning involves aggressive tax avoidance schemes. The worst thing a director can do is not seek advice because they feel familiar with or have built up a lot of experience with the subject area. This can result in tunnel vision and an unwillingness to face receiving a contrary opinion. This failure means that risks to the company and perhaps its creditors are not identified and properly assessed. As the quote says this can lead to plans going awry with expensive and potentially life-changing consequences, especially for an otherwise experienced director maybe approaching retirement.
BACKGROUND
The Company was a small local general practice with around 20 or so employees which provided a full range of accountancy and taxation services to a wide variety of clients predominantly in the SME sector. The Company acted for 300 to 400 companies and prepared up to 1,000 tax returns a year. The two Respondent director/shareholders were both qualified accountants of long-standing, and each had held many directorships over that time.
In running the Company, the Respondents believed that they had been significantly underpaid compared to local accountants in the area. As a result in 2010 the Company transferred £450,000 into an EBT and EFRBS scheme for the benefit of employees and their families, but only £13,250 was provided for the benefit of employees other than the Respondents. Interest free loans were paid by the Scheme Trustees to the Respondents for their personal benefit which were never repaid. The Respondents relied upon the promotional material indicating the schemes had supporting opinions from leading tax silks and so did not seek independent legal advice as they felt the risk of the schemes failing was “remote“. On that basis they also did not set aside an appropriate reserve for the Company’s liabilities if HMRC later chose to investigate the Company’s participation in the schemes. HMRC did in fact open enquiries in relation to the Company’s returns between 2011 and 2013 and during 2014 raised various assessments and determinations for PAYE/NICs and CT totalling £314,322.71. In the meantime, the Company ceased trading in May 2012, seven months after the first enquiry letter and its business was transferred to an LLP. In 2013 an application was made to strike the Company off which was suspended. The Company entered CVL on 29 March 2016 with HMRC’s debt being valued by the Respondents at £1 and having not filed accounts since the year ended 30 April 2011.
The Claim
Our clients made an application under s.212 of the Insolvency Act 1986 on the bases that the Respondents (i) knew there was a risk that HMRC would challenge the schemes (ii) failed to maintain any reserve for the high probability of HMRC challenging the schemes, depleting the Company’s assets and leaving it with tax liabilities that it could not pay and (iii) personally benefited from the payments made into the schemes. In causing the Company to make the extractions, our clients maintained that the Respondents acted in breach of their duties as directors of the Company.
The Respondents contested the Application on the bases that (i) the Application was time-barred (ii) the Company was at all times solvent and did not need to maintain a reserve to account for HMRC liabilities because they reasonably believed the Schemes were lawful and in the interests of the Company (iii) the Duomatic principle applied to ratify the Respondents’ conduct, the Company being solvent (iv) Respondents’ sought relief under s.1157 CA 2006 and (v) that they are entitled to a declaration that our clients must indemnify them against all liabilities incurred in defending the proceedings pursuant to clause 24 of the Company’s Articles of Association.
The Decision of the Court
ICC Judge Mullen found for our clients to the extent of £436,500 and dismissed the Respondents’ counterclaim. The Judge reached this decision upon the following grounds:
- The payment into each scheme have left the Company insolvent on the balance sheet and cashflow bases rendering it unable to meet the assessments later raised by HMRC. Such assessments were fully due and payable once raised by virtue of statute and remained so even if subject to appeal until the Tax Tribunal decided whether or not to set aside those assessments;
- Even though the Respondents maintained that the assessments had been incorrectly determined by HMRC, the amount of tax they determined was payable could still not be met by the Company;
- There was no evidence to support the assertion by the Respondents that the monies loaned by the scheme trusts had been paid to the Company;
- nor was there any evidence to show that the Company would have been able to trade out the financial difficulty it found itself in due to it entering into the schemes. The Company had not filed accounts for the period after 30 April 2011 and so there was no evidence that the Company had traded at all after that date. Indeed, the Judge observed that this was an “extraordinary omission” on the part of the Respondents as chartered accountants and gave the impression that that they were seeking to obscure the Company’s trading position. In addition, no information had been provided about the trading undertaken by the successor LLP;
- the duty to creditors set out in the case of BTI 2014 LLC v Sequana SA [2022] UKSC 25 had been triggered as the Respondents had been shown to have a sufficient level of knowledge that there was a real risk the Company had been rendered insolvent by the schemes. This level of knowledge was based on 5 factors including the Respondents’ acceptance that the schemes were aggressive and heavily caveated by their promoters, the fact that specialist opinions were even required indicted they were sufficiently contentious and the risk could not be said to be remote.
As experienced accountants the Respondents would have been able to calculate the tax that would be due and realise that the Company would have been insolvent. However, they never once asked themselves how the tax would be met if the schemes were said to ineffective by HMRC or considered a strategy to meet that liability. The Judge stated:
“They do not appear to have done so at all. On the contrary, in my judgment, they closed their mind to the risk to the interests of creditors. They did not obtain any independent advice as to the schemes or how the risks to the Company should be addressed as a matter of company law, even when advised to do so. The tax advice they had came from the promoters of the schemes, with a product to sell, and from tax counsel whose advice was directed to those promoters. It was inevitably partial. Sophisticated financial professionals such as the Respondents cannot but have appreciated this. It was advice that they were only shown and not allowed to retain for themselves.”
The Respondents never explored the availability or the cost of a second opinion. The Judge also dismissed the Respondents’ assertion that such advice would have confirmed the opinions advanced by the promoters. Indeed, their failure to explore a second opinion suggested that “they did not wish to be told something but they did not want to hear“. An honest and intelligent director would have considered the creditors’ interests and considered how the tax liability would be met. Possible solutions would be to fund a reserve by making a smaller payment into the schemes or by use of another source of finance. A reasonable director would not have come to a decision to transfer such a large sum away from the Company, thereby taking away its ability meet the possible tax liability in light of the obvious risks of challenge by HMRC and any evidence that the risks of such challenge were minimal. The main purpose of the Respondents was to “extract as much of the Company’s capital as possible for their own benefit… without regards to the interest of HMRC as creditor“. Even if the Respondents had reinvested the moneys into the Company, the Company did not benefit as they were withdrawn shortly thereafter at a time when HMRC had begun its enquiries.
With respect to potential defences as the Judge had determined the Company was insolvent the Respondents were not able to avail themselves of Re Duomatic [1969] 2 Ch 365 to validate their actions. Neither could the Respondents seek relief under section 1157 of the Companies Act 2006. Whilst the evidence did not show that the Respondents had any dishonest intent by entering into the schemes; based upon their behaviour it could not be said taking all the factors into account that they had acted reasonably.
Finally with regards to limitation our clients could rely upon section 21(1)(b) of Limitation Act 1980 as following the case of Burnden Holdings (UK) Ltd v Fielding [2018] UKSC 14 the directors were trustees who had received trust property in the form of the Company’s money which they had sought to use for their own purposes and benefit. Even if the court accepted that the Respondents had reinvested these monies back into the Company, they were no longer the Company’s monies but the Respondents’ personal monies and therefore would have been used for their own purposes. As a result, no limitation applied to our clients’ claim.
This article is for general information purposes only and does not constitute legal advice or a comprehensive statement of the law. Specific legal advice should always be sought in relation to individual circumstances.
Meet the team:
Ian Rees
- Associate
- Insolvency & Restructuring
