Purkiss v Kennedy & Ors [2024] EWHC 1081 (Ch) is another judgment in a string of cases arising out of schemes designed to enable self-employed individuals to avoid paying income tax and national insurance on their remuneration. The decision of the Supreme Court in RFC 2012 Plc v AG for Scotland demonstrated the flaws that often mean such schemes fail.
In this case the liquidator of Ethos Solutions Limited, which was the umbrella company which promoted and operated the tax avoidance scheme, brought proceedings against 63 individuals seeking relief under s 423 Insolvency Act 1986. The claims against a number of them were settled, others were discontinued, yet others resulted in a judgment. The trial before Rajah J concerned 23 remaining respondents.
The company’s problems began, as they often do, with HMRC assessing it for income tax and NIC, in this case for some £2.2 million. The company went into creditors’ voluntary liquidation without making payment or appealing.
The liquidator’s case was that:
(a) the scheme was a composite transaction at an undervalue within the meaning of s 423(1)(c) because the consideration the company received was significantly less than the liabilities it incurred as a result of it;
(b) the company entered into each transaction for the purpose prohibited by s 423(3) since the purpose of the arrangements, by which the respondents received most of their earnings in the form of “loans” rather than salary, was the avoidance of income tax and NIC that would otherwise have arisen, thus prejudicing the interests of HMRC (and making recovery more difficult by using an offshore trust);
(c) the court should exercise its discretion under s 423(2) to make orders against the respondents requiring them to pay the company a sum equivalent to the income tax and NIC which should have been deducted from the sums paid to the trust for their benefit (or other orders as the court thought fit).
The application raised issues as to the meaning and effect of s 423.
Rajah J considered first whether the transactions had been at an undervalue. He concluded they were and that s 423(1) was satisfied: the company had indeed found itself in a worse position as a result of entering into the transactions than the position it would have been in had it not entered into them.
He considered next whether the company had entered into a prohibited transaction, namely one that entered into for the purpose of putting assets out of the reach of a person (in this case HMRC) who had, or might have, a claim against it, or with the intention of prejudicing the interests of that person in relation to a claim they had or might make.
Rajah J described the applicant’s primary case as being that the company had transacted for a prohibited purpose: it had entered into the transaction in the mistaken belief that the respondents could thereby avoid paying income tax and NIC on the remuneration they received for their services to end users; there was no dispute that that was the raison d’être of the scheme. Leading counsel for the applicant submitted that, as the scheme was intended to avoid tax arising in respect of the respondents’ remuneration, it necessarily prejudiced HMRC’s interests in relation to the claim it would have had in respect of tax. An intention to prevent a tax liability arising was an intention to prejudice the interests of HMRC in respect of the hypothetical claim for the tax liability which was avoided. The hypothetical claim was one which HMRC “may make” for the purposes of s 423(3)(b).
The judge found the applicant’s submissions on this point to be flawed:
“I note that the consequences of [leading counsel for the applicant]’s submissions, if correct, are that any steps taken with the intention of minimising tax, and all legitimate tax avoidance, would be a prohibited purpose. That would be a remarkable outcome. Lord Tomlin famously said in IRC v Duke of Westminster [1936] 19 TC 490: ‘Every man is entitled if he can to arrange his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be’.”
He thought the consequences of leading counsel’s submissions were too wide: if correct, they would mean that at least two established authorities (Re Marylebone Warwick Balfour Management and Asertis Ltd v Heathcote) were wrong when as he said, “In both cases it was assumed that a legitimate tax avoidance purpose was not a prohibited purpose.” He analysed the position as follows:
(a) S 423(3)(a) was concerned with the prohibited purpose of putting assets out of the reach of “a person who is making [a claim], or may at some time make, a claim.” That clearly contemplated a current claim or a future claim. S 423(3)(b) made it a prohibited purpose to otherwise prejudice “such a person in relation to the claim which he is making or may make.” The words “may make” in s 423(3)(b) were a reference to the claim in s 423(3)(a) that a person “may at some time make.” The “claim” with which both s 423(3) (a) and (b) were concerned were claims which a person was presently making or one which a person might make in the future.
(b) The tax avoidance purpose relied on in this case was that the scheme would ensure that no income tax and NIC liability arose in relation to the remuneration received in respect of the respondents’ services. The purpose was therefore that HMRC would have no claim which it could make and not to prejudice a claim which it was making at the time of the transaction or might make in the future.
(c) He did not consider there to be ambiguity as to what s 423(3) meant. If there were, it had to be remembered that the policy behind s 423 was that debts were paid before gifts were made. That policy was not undermined by a transaction which prevented a debt from arising; it was consistent with it.
As to the applicant’s secondary case that the court should infer that the company had entered into each transaction for the purpose in s 423(3)(a) (placing assets beyond the reach of HMRC), he held that there was insufficient material to justify an inference that from the outset the company’s purpose had been to impede HMRC: “On the contrary, I note that the Company openly identified in its filed accounts the total of the payments it had made to the Trust and that was the basis on which HMRC raised the assessments which it did.”
In the circumstances the s 423(3) requirement had not been satisfied.
The judgment highlights some of the difficulties attendant on recourse to s 423 relief, in particular, in this case, the difficulty in distinguishing between the purpose of entering into a transaction and the effect of doing so; but although it is important to distinguish between the two, the more beneficial the outcome to the person transacting, the more ready the court is likely to be to infer the intended purpose (see, for example, Akhmedova v Akhmedov).