Corporate governance and the UK’s insolvency regime have come under increasing scrutiny in recent years, on the back of a litany of major corporate failures. The UK Government has completed several consultations aimed at tackling real and perceived failings, including the Review of the Corporate Insolvency Framework in 2016, and the consultation on Insolvency and Corporate Governance launched in March 2018.
The aim has been to seek out views on how to reduce the risk of company failures occurring as a result of poor governance and stewardship, and to garner feedback on proposed improvements to the wider insolvency and corporate governance frameworks.
From its response to the consultations, published in August 2018, the UK Government’s ongoing political focus on governance seems set on driving changes that could, from a director’s perspective, substantially increase risk. Directors will, therefore, need to be vigilant and keep abreast of developments.
What do we already know?
Draft legislation is expected covering a diverse range of issues, including directors’ liability to protect shareholders in the sale of a distressed entity, and the extension of provisions under the current directors’ disqualification legislation to dissolved companies.
However, while we await the details of how a number of the recommendations in the 2018 report are implemented, we do know that the Finance Bill 19/20, as currently drafted, introduces a basis on which individuals with a ‘relevant connection’ (including directors/shadow directors and members of an LLP) may be jointly and severally liable for certain company tax liabilities in respect of periods ending from and after 6 April 2020 and/or any event or default occurring from that date. In addition to joint and several liability in cases of tax evasion and avoidance, from 6 April 2020, directors or participators in a company may be liable in cases in which HM Revenue and Customs (HMRC) is satisfied that certain criteria are met, provided that HMRC issues a notice of liability within two years of becoming aware that the conditions are fulfilled.
The conditions are:
- Broadly, the conditions are fulfilled in two or more companies where it can be demonstrated that: the individual has a ‘relevant connection’ within the five years prior to a notice of liability being issued; the companies have entered into insolvency within that five year period; and, at the time of insolvency, they had: (i) unpaid tax liabilities; (ii) failed to submit a return / document as required; or (iii) a claim, declaration or application for approval which had not yet been determined;
- A new company is created that is carrying on a trade or activity the same as “or similar to” the two entities (or if more than two, any two of the entities) during the five-year period and the individual has a ‘relevant connection’ with that new entity; and
- At the time notice of liability is issued by HMRC to the individual, one of the original entities has an unpaid tax liability of more than £10,000 and that tax liability amounts to more than 50% of the total liabilities of the relevant companies.
If a notice of liability is issued, the individual will be jointly and severally liable:
- Together with the new company for any tax liability of the new company that is unpaid on the day on which notice of liability is given, and for any tax liability that the new company incurs during the five-year period following the notice being given while the notice continues to have effect; and
- Together with the original entities, for any tax liability of those entities that is unpaid on the day on which notice is given.
That individual’s liability is unaffected by the relevant corporate entity ceasing to exist.
What it means for directors
These changes are intended to combat the practice of setting up phoenix companies. There is, undoubtedly, merit in eradicating phoenixing, where scant regard may be given to the rights of creditors.
These broad proposals, however, pose a real risk to directors or participants in any group structure, particularly taking into account the low threshold of tax liabilities and the vague references to trade and activities that are ‘the same or broadly similar’.
If the proposals are introduced in their current form, it could have an adverse impact on the willingness of individuals to act as directors in group companies. Individuals taking up posts in such group structures would be required to ensure their own due diligence covers, in sufficient detail, the wider group’s tax liabilities, and to reflect on whether any relevant risk is acceptable, or indeed insurable.