HMRC looking to prevent directors from using insolvency to game the system and avoid paying tax

There are clear signs that HMRC is ramping up its efforts to improve its tax collection rates.

Among several initiatives, about which there will be more in subsequent blogs, it is focusing on what it calls the “misuse” of insolvency as a means of tax avoidance or evasion.

Since the loss of its preferential status on enactment of the Enterprise Act 2002, HMRC has to wait in line alongside other unsecured creditors during insolvency proceedings.

In a consultation document issued in April HMRC is now proposing that it should be able to use litigation to allow an insolvent company’s tax debts to be transferred to the person(s) responsible for the avoidance/evasion or that directors or shareholders should be made jointly and severally liable for the company’s tax debts.

HMRC’s discussion document acknowledges that Insolvency Practitioners (IPs) must still have a duty of care to the interests of creditors as a whole.

Assets realised into cash during insolvency are distributed to creditors by the IP according to strict insolvency rules. Secured creditors, normally banks and other lenders, and then employees as preferential creditors are paid in full before sharing out any remaining balance among unsecured creditors.

Given the payment priority, HMRC like the other unsecured creditors rarely get anything.

However, if HMRC were to pursue directors through the courts the question is who will be liable?

Will HMRC move up the ranking of creditors of the insolvent company which could risk loss to secured and preferential creditors, and heap further losses on unsecured creditors?

Or will directors and shareholders become personally liable for overdue tax?

There is also a worry that if HMRC proposals were approved this would undermine the recent shift in insolvency regulation, which included a moratorium on creditors’ action, to allow time for a restructure and turnaround plan to be devised.

HMRC is clearly redoubling efforts to recover the maximum amount of tax debt it can. This week a Freedom of Information request revealed that its spending on debt collection services had increased by more than 500% in three years, from £6.2m in 2014 to £39.1m in 2017.

phoenix company and tax debtsThe implications on a rescue culture might go further given that HMRC often exercise their blocking vote to reject proposals for a Company Voluntary Arrangement. This generally leaves a Phoenix as the only option.

In other developments around insolvencies

A HM Treasury minister has urged the Financial Conduct Authority (FCA) to take action on the use of phoenix companies, which it has been argued, allow directors of an insolvent company to walk away from their debts to creditors by setting up a new (phoenix) company enabling it to effectively carry on trading under a different identity.

Robert Jenrick, the Exchequer secretary to the Treasury, was responding to a case where a company offering financial advice had used the phoenix option to effectively “walk away” from its previous business taking its clients with it. However, this had enabled its owner to retain his FCA approval and avoid paying compensation to some unhappy clients despite a Financial Ombudsman investigation finding that the previous company had made “completely unsuitable” investments for the complainants, who had then lost money.

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