In January 2020, Brexit was the focus of attention for many. However, the last nine months have brought challenges and uncertainty beyond those imagined with the added complications and threats posed by COVID-19.
This has been a concerning time for many as employees, business owners and their company officers have been forced to grapple with a series of rapidly evolving government measures, guidance and new legislation while trying to evaluate the extent of the financial impact and how to discharge their duties.
While there have been many positive measures introduced to provide comfort to directors, LLP members and others involved in the management of a business (see our previous article on some of those measures), some changes may well tip the balance of risk too far and leave many of those parties open to significant, unquantifiable financial risk.
What are these additional risks?
The Finance Act 2020 (Act) was enacted on 22 July 2020. One of its most significant but not widely publicised features was to introduce, with effect from that day, joint and several liability for directors, LLP members and other individuals for certain tax liabilities of companies and LLPs.
The main purpose of the provisions is two-fold:
- tackling tax avoidance and evasion practices; and
- tackling ‘phoenixing’ of companies and repeated non-payment of taxes more generally due to insolvency or potential insolvency in order to change the behaviours of those involved in such conduct by providing direct recourse to individuals.
Section 100 and Schedule 13 of the Act detail the circumstances in which HMRC can issue a notice of liability against individuals for those tax liabilities. We have summarised the fuller details of the provisions in the appendix included at the foot of this article. The key thing to note is that, where HMRC issues a joint liability notice in respect of tax avoidance or evasion (including penalties for facilitating it), or, repeated insolvency or non-payment, the relevant individual shall be jointly and severally liable for the relevant tax liabilities.
What are the key issues arising from these new provisions?
1. The new provisions represent a significant change in risk to officers of corporate entities or those otherwise involved in the management of the entity; they have the effect of breaking the corporate veil afforded by the limited company and LLP status to make the officers responsible for managing its affairs liable.
2. What tax liabilities are caught? This is calculated by reference to the periods in which the tax liabilities arise. The provisions do not cover tax liabilities that relate to a period ending 21 July 2020, or, those (other than relating to a period) arising from an event of default occurring before 21 July 2020. A tax liability relates to a period if it arises in respect of a particular tax year, accounting period or other period, or the amount of the liability is calculated by reference to a particular period.
3. The provisions on liability extend to certain individuals, including those who are directors, shadow directors, members of an LLP, shadow members of an LLP and participators, and in some circumstances those concerned (directly or indirectly) or taking part in the management of the entity. Participator is defined by reference to Section 454 of the Corporation Tax Act 2010 and includes shareholders, loan creditors and others.
4. Liability for tax evasion and avoidance arrangements and conduct will arise where the entity is subject to an insolvency procedure or at serious risk of becoming subject to an insolvency procedure. Additional conditions under which liability is triggered include:
- the individual having had active engagement in the arrangements or conduct;
- receiving a benefit in the knowledge it arose from that conduct when the individual was a specified officer; or
- taking part in or facilitating the conduct or arrangements whilst holding office or taking part in the management of the entity.
These provisions are very widely drafted. In particular, knowledge is considered to be that which the individual reasonably could be expected to know. Receipt of benefits will extend to persons connected to the individual in terms of Section 993 of the Income Tax Act 2007 (including relatives, spouses, civil partners and others) and is therefore far-reaching. Further, the tax liability does not actually need to have arisen or be unpaid at the time the notice is issued. So long as there is, or is likely to be, a tax liability relative to the arrangements or conduct, and a serious possibility that some or all of it will not be paid, that will be sufficient. Where the criteria are met and the notice is issued in the form specified, the individual is jointly and severally liable for the tax liability of the entity. The provision is to prevent misuse of company insolvency to retain proceeds of tax avoidance and evasion. Accordingly, there does not appear to be any limit on that liability.
5. The provisions regarding liability for penalties relative to tax evasion and avoidance are equally broad and will apply where a penalty is imposed by HMRC, or First Tier Tribunal proceedings have been commenced for a penalty to be imposed, due to breach of obligations in relation to failure to disclose tax avoidance schemes, promotion of schemes and other relevant matters. Again, there is no need for an insolvency procedure to have commenced. Rather, it is enough that an insolvency procedure is a serious possibility and that there is a serious risk that some or all of the penalty will not be paid.
6. For repeated insolvency or non-payment, the conditions for notice being issued are slightly more complicated. In essence, notice of joint and several liability can be issued to certain individuals to impose liability on them for the tax liabilities of certain insolvent entities, and certain existing and future tax liabilities of new entities with which the individual has a relevant connection.
The conditions applicable are broadly:
- that the individual had a relevant connection to two or more entities (‘old entities’) that have entered into an insolvency procedure in the preceding five years; and
- at the time of the insolvency procedure, each entity had a tax liability or had failed in respect of a tax liability (e.g. failure to complete a return, make a declaration), or an act or omission occurred that prevented HMRC from dealing with the tax liability of the entity.
Where those conditions have been met and the individual has a relevant connection to one or more ‘new entities’ carrying on the same or a similar trade or activity to any two or more of the old entities during that five-year period, and one or more of the old entities had a tax liability equating to more than £10,000 and more than 50% of the total unsecured liabilities of the entities, HMRC can issue a notice of joint and several liability to that individual for both the tax liability of the old entities and the existing and certain future tax liabilities (over the next five years) of the new entities. HMRC has two years to issue the notice from when it became aware of sufficient facts to conclude that certain conditions had been met. A number of issues flow from this provision:
- The definition of relevant connection to the old entities and the new entities differs (paragraph 3(10) of Schedule 13). The latter is more extensive and includes those directly or indirectly concerned in or taking part in the management of the new entities. Further, it applies where the individual has or had a relevant connection within the previous five-year period. Liability would therefore appear to continue notwithstanding the fact that the individual is no longer involved in the old or new entity. It would therefore appear that it is not necessary that the old and new entities are connected, it only requires the individual to have a relevant connection to the entities. There are only two qualifications that appear in the explanatory notes to the legislation:
- “the powers… will not be used to target ‘turnaround specialists’ whose relevant connection is part of a genuine attempt to save the company from failing”; and
- being a participator in the company alone will not result in a notice being issued if “HMRC is satisfied the person acted in good faith and had no material influence over the company’s affairs”. Thus, it would seem being a shareholder alone may not result in automatic liability.
- Liability can be triggered where the new entities are carrying on or have carried on in the five-year period a similar trade or activity to the old entities. However, there is no guidance as to how the same or similar trade or activity will be interpreted. Is it only intended to catch individuals operating the same businesses under the same or similar names, contrary to the phoenix provisions in the Insolvency Act 1986? The drafting goes beyond that.
- There are no exclusions or exemptions from liability, only the two qualifications noted in the explanatory statement above. Thus, it is unclear how this operates where the exemptions to the phoenix provisions apply.
- It is unclear how the quantum of the tax liability threshold is calculated and whether it only requires one of the entities to have a tax liability of more than £10,000 and 50% of the total unsecured liabilities, or if both entities are required to meet that condition, or if it is an aggregated position. As drafted, it would appear to be the aggregate of both companies meeting those thresholds. However, depending on the approach taken, it may make a significant difference in assessing the risk of liability.
- Otherwise, it is safe to say that this particular provision exposes directors and members (and others), particularly those of group entities or those involved in a similar line of business to a previously insolvency entity (whether that is following a pre-pack or other acquisition) to a potentially unquantifiable financial risk in terms of old and new tax liabilities of the relevant entities.
7. There is no escaping liability where the relevant entities have ceased to exist. Thus, dissolution following insolvency does not appear to impact liability. Instead, the liability will be treated as whatever the liability was immediately prior to the entity ceasing to exist.
8. In addition, it is worth noting that the definition of insolvency procedure is much wider than one would expect. It includes, for example, instances in which a company or LLP is undergoing or has undergone a winding up (other than an Members’ Voluntary Liquidation (MVL), unless the debts are not paid in full within the relevant 12-month period); dissolution; administration; receivership; Company Voluntary Arrangements (CVAs): Part 26 schemes, arrangements and reconstructions; or striking off the register under Section 1000 or 1003 of the Companies Act. It also extends to processes outside the UK. Interestingly, it does not currently appear to refer to restructuring plans under Part 26A of the Companies Act 2006. However, that may change. The fact that it catches CVAs will undoubtedly be a concern, given their current prevalence.
9. There are some provisions enabling withdrawal or modification of notices after they have been issued. In particular, HMRC must withdraw if the conditions were not met when the notice was issued or if it was not necessary for the protection of HMRC for the notice to continue to have effect. It is not clear who makes that decision. If it is HMRC, that is not entirely helpful. Otherwise, the rights of review and appeal are limited and, again, most of the decisions will still rest with HMRC, save for those occasions where the First Tier Tribunal is hearing the appeal. The time period for seeking a review or appeal is also very short – 30 days following notice being given, unless extended. Importantly, it is worth noting that if an individual does make payment and the notice is subsequently altered, withdrawn or even revoked on appeal, the individual is not entitled to recover any payment already made. Individuals will therefore need to consider and balance carefully the risks of non-payment (e.g. the commencement of personal insolvency proceedings) against making payment and losing any right of recovery if the notice is subsequently withdrawn or reduced in value. It is also worth highlighting that there is limited scope for the individual to dispute the company’s tax liability and that this will only be possible in certain circumstances.
10. It is clear that, under these provisions, HMRC can make a number of judgements to impose joint and several liability on an individual. These include the assessments around at what stage there is a serious risk of insolvency and/or non-payment of a liability and whether someone is directly or indirectly involved in the management of the entity. The subjective view of HMRC is therefore critical and no doubt troubling for those individuals who could find themselves at risk of liability.
What does all of this mean for officers and those involved in the management of a company or an LLP?
While the provisions are aimed (quite correctly) at tackling avoidance, evasion and phoenixing of entities, they clearly go beyond that. Indeed, HMRC has been afforded very wide discretion to impose liability with little protection for the individuals concerned. It remains unclear exactly how and when HMRC will look to wield these extensive powers. In the absence of any real guidance or feel for approach, it is safe to say that, as currently drafted, there are significant implications for directors of group companies and members of LLPs both pre and post entry into one of the insolvency procedures noted. As highlighted above, the provisions may be particularly troubling for those who have or will be embarking on CVAs or pre-pack transactions, particularly given the low threshold of tax liabilities for repeated insolvency cases.
In view of the extent of the risk posed, we may well find that directors and individuals taking up posts in group structures or being involved in similar trade entities will now be very concerned about doing so. Further, it could result in companies paying their tax liabilities ahead of other creditors, which could potentially result in other challenges due to preference, alienations or transactions at undervalue provisions being breached.
What can individuals do to try to mitigate or manage the possible risks?
- Insurance may provide some comfort for this, if appropriate policies are available. It would be worth checking any existing Directors' and officers' liability insurance policies or purchasing an appropriate policy while ensuring there is appropriate run off cover.
- Track any former and existing appointments, shareholdings and other involvement with any entities carefully and ensure that appropriate records are obtained to enable proper consideration as to whether there are any relevant connections or entities carrying on a same or similar trade or activity.
- Ensure that all financial information is made available to you to assess and forecast tax liabilities and understand how the tax liabilities will be met.
- If resigning from office or selling shares, consider obtaining warranties as to the extent of any tax liability and if appropriate, obtain an indemnity from the company to provide a right of recourse to the company, if possible.
- Take appropriate legal and financial advice to enable the risk of liability to be assessed and to consider the options available.
Allana Sweeney is a Senior Associate in Shepherd and Wedderburn’s restructuring and business advisory team. For further advice on this or another related matter, please contact Allana on 0141-566 7215 or at firstname.lastname@example.org.
Tax avoidance and evasion
Paragraphs 2, 6 and 7 of Schedule 13
The circumstances giving rise to a notice being issued requires that:
1. The company has entered into tax-avoidance arrangements or has been engaged in tax evasive conduct (Condition A).
2. The company has become subject to an insolvency procedure or there is a serious possibility that it will (Condition B).
3. The individual either:
a. Was responsible (either alone or jointly) for the company entering into the tax avoidance / evasion arrangements or conduct; or received a benefit which, to the individual’s knowledge arose wholly or partly from those arrangements or that conduct, at a time when the individual was a director, shadow director, or participator. It is worth noting that an individual is treated as knowing anything they can reasonably be expected to know and is treated as receiving anything that is received by a person with whom the individual is connected;
b. The individual took part in, assisted with or facilitated the tax-avoidance arrangements or tax-evasive conduct at a time when the individual was a director or shadow director or was concerned (directly or indirectly) or was taking part in the management of the company
4. There is or is likely to be a tax liability referable to the relevant arrangements or conduct (Condition D).
5. There is a serious possibility that some or all of the relevant tax liability will not be paid (Condition E).
Penalties for Tax Avoidance and Evasion
Paragraph 5 of Schedule 13
Linked to the above provisions, there is also joint and several liability imposed in relation to penalties for avoidance or evasion. In particular, notice of liability can be issued where:
1. A penalty under the relevant provisions has been imposed by HMRC, or proceedings have been commenced under the First Tier Tribunal for a penalty under any of those provisions to be imposed. The relevant provisions include penalties for breach of obligations regarding disclosure of tax avoidance schemes, promoters of tax avoidance schemes, enablers of offshore tax evasion or non-compliance, enablers of defeated tax avoidance and breach of certain obligations relating to disclosure of tax avoidance schemes by promoters etc of schemes) (Condition A).
2. The company is subject to an insolvency procedure or there is a serious possibility of it becoming subject to an insolvency procedure (Condition B).
3. The individual was a director, shadow director, or participator in or of the company at the time of any act or omission in respect of which the penalty was imposed or proceedings for the penalty were commenced (Condition C).
4. There is a serious possibility that some or all of the penalty will not be paid (Condition D).
An individual who receives the notice is jointly and severally liable with the company and any other individual receiving notice for the amount of the penalty.
Repeated insolvency and non-payment
Paragraph 3 of Schedule 13
1. There are 2 or more companies (the old companies) in the case of each which:
- The individual had a relevant connection with the company at any time during the five year period prior to the notice being given. Relevant connection in this regard means the person was a director, shadow director or participator in the company;
- The company became subject to an insolvency procedure within that five year period; and
- At the time of the insolvency procedure: (i) the company had a tax liability; or (ii) had failed to submit a relevant (i.e. as to whether there is a tax liability or its amount) return or other document or failed to make a declaration or application that was required; or (iii) the company submitted the relevant return, document, or made the declaration or application but due to an act or omission on the part of the company, HMRC were prevented from dealing with it.
2. A new company is or has been carrying on a trade or activity the same or similar to the trade or activity of the two old companies or any two of them (where there are more than two).
3. The individual had a relevant connection with the new company during the 5 year period. Relevant connection in this regard means the individual is or was a director, shadow director, participator or is or was concerned (directly or indirectly) or taking part in the management of the company.
4. When the notice is given:
- At least one of the old companies has a tax liability; and
- The total amount of the tax liabilities of those companies is more than £10,000 and more than 50% of the total amount of those companies’ liabilities to their unsecured creditors.
Where these criteria are met and a notice is given in accordance with the terms, the individual is jointly and severally liable:
- With the new company and any other individual who is given notice for the tax liability that the new company has on the day the notice is given and any tax liability of the new company which arises during the next 5 year period whilst the notice continues to have effect; and
- if the old company has a tax liability on the day on which the individual is given a notice, with that company together with any other individual for that liability. It should be noted that where a notice is given in relation to a company which has ceased to exist, the liability is to be treated as being to the amount of the tax liability immediately prior to the company ceasing to exist.
HMRC are unable to issue a notice on the above provisions more than two years after the date on which HMRC first became aware of facts sufficient to enable them to reasonably conclude that the conditions at A to D above have been met.