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How Liquidator Investigations Can Induce Settlements In Tax Avoidance Cases

View profile for Michael Stevens
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With the release of the Paradise Papers, the spotlight has been shone on high profile abuses of tax legislation, where individuals have subverted the letter of the law to reduce their personal tax position, often in the sum of hundreds of thousands of pounds.

Such transactions are artificial and highly contrived, serving no commercial purpose other than to escape the obligation to pay tax.

Historically, cash rich businesses have invested their funds in Employee Benefit Trusts and other offshore Trust Structures, which are known tax avoidance schemes and have been given scheme reference numbers under HMRC’s Disclosure of Tax Avoidance Schemes (‘DOTAS’) regime.

These schemes are not approved by HMRC.

Quite often an “employer” (the company) acting by its director(s) will give a “loan” to such a scheme for the benefit of an “employee” (also the director(s)), which ultimately is never repaid. These funds transferred are deemed to constitute ‘‘disguised remuneration’’ and the employer company incurs an additional tax liability on the unpaid PAYE and NIC on the remuneration paid into the scheme.

Schemes which advertise assets (e.g. cash or shares) held in a ‘fiduciary capacity’ (i.e. on behalf of another party) argue that income received via this mechanism is tax free, being received in the form of loans rather than income. Renaming the receipt does not, however, change the commercial reality that income has been distributed from a company without being subject to the correct tax.

Insolvency

Companies which have historically used tax avoidance schemes and subsequently entered a formal insolvency procedure are not free from HMRC’s grasp.

Upon an initial view, it is understandable to think that a liquidator would not be concerned by this fact. Given that the crystallisation of an additional tax liability only further increases a company’s debt to the Crown, and in the event that no dividend is payable, no further action is required.

However, this is not the view an office-holder is likely to be taking. Liquidators have an overriding duty to collect in the assets of a company and realise the maximum possible return for creditors. Liquidators need to act in the best interests of creditors and recent publications from HMRC show not only what liquidators should be looking out for within their investigative responsibilities, but also opportunities for settlements, which could result in significant realisations in a company’s insolvent estate.

The Approach Of HMRC

In October 2017 HMRC published the ‘Measuring Tax Gaps 2017 Edition’ which estimated that, as a direct result of tax avoidance schemes, in 2015/2016 the difference between the expected amount of tax collected against the actual collected tax revenue was £1.7 billion.

This significant cost to society has decreased in recent years (from £3.1 billion in 2010/2011 to £2.2 billion in 2012/2013) evidencing HMRC’s strong commitment to reducing tax avoidance and holding users of historic tax avoidance schemes accountable for the strategies employed.

The Autumn 2017 Budget announced an additional £155 million would be invested by HMRC to address a range of tax avoidance and evasion activity. On 7 November 2017 HMRC issued further, detailed, guidance on how taxpayers can settle their affairs in respect of tax avoidance matters.

If liabilities have not been settled by 5 April 2019, a new ‘’Loan Charge’’ will be applied to old and new tax avoidance cases and where this would apply to the employer in the first instance (i.e. the company), most importantly, the 2019 Loan Charge may be transferred to an employee (i.e. the individual who received the benefit of the disguised remuneration – namely, company directors).

Director Misfeasance

The improper use of an Employee Benefit Trust or other avoidance schemes gives rise to all manner of potential director misfeasance and liability under section 212 of the Insolvency Act 1986 (“Section 212”). By using an unapproved scheme in order to avoid tax liabilities there is quite clearly a retention of crown monies. In addition to this there are also possible preference payments, transactions at undervalue and putting assets out of the reach of creditors.

From the perspective of a liquidator, a director who has personally benefited from the abuse of an unapproved scheme could find themselves on the HMRC “Hit List” and become personally liable to HMRC from 5 April 2019 by virtue of the Loan Charge mechanism. This means there is significant incentive for a company director to settle their entire Section 212 liability with the liquidator, in conjunction with HMRC, before April 2019.

HMRC are encouraging such settlements and will work with a liquidator to negotiate a settlement sum to be paid to the insolvent company by a director in order to contribute to the avoided PAYE/ NIC liabilities and settle a director’s potential personally liability.

A recent forensic investigation identified untaxed contributions into an Employee Benefit Trust in excess of £1.3 million spanning a three year period, giving rise to a significant unpaid tax liability. In cases where known tax avoidance schemes are in operation, the sums involved are often material.

The scope for achieving recoveries under Section 212 is therefore high, as it can be proven that company directors have personally benefitted from receipt of funds from tax avoidance entities, evidencing their personal asset base is sufficient to fund a potential settlement to the liquidation estate.

It is important for liquidators take a serious approach towards investigation and settlement. HMRC have the power to restore dissolved companies back onto the Register in order to pursue these avoided liabilities and therefore even having a company wound up prior to the new Loan Charge being implemented is not enough to keep away from HMRC.

Where office-holders have access to forensic services within their firm, or independently via a third party, they can assist insolvency practitioners and HMRC in conducting an independent investigation into a company’s trading to identify amounts paid into historic tax avoidance schemes and quantify the potential misfeasance claim against directors.

In conducting an electronic review of company bank statements and base records, personal assets and accounts of the directors can be identified from which to fund a potential settlement into the liquidation estate.

A forensic investigation can therefore benefit office holders and legal advisors in determining the scope to pursue further action against company directors under Section 212, thereby achieving significant realisations for the benefit of creditors and to assist with cost recovery for the estate.

Forensic investigations can assist with:

  • Quantifying amounts paid into avoidance schemes
  • Unravelling complex offshore trust structures
  • Review of Trust Documents and scheme information
  • Automated bank transaction review to identify all scheme expenses
  • Detailed review and reporting on company trading and potential asset shifting
  • Tracing movement of funds
  • Identifying transactions with directors and associated parties
  • Providing specialist tax advice

Once the investigatory side has taken place it will then be important for an insolvency practitioner to evaluate their options with regards to any potential misfeasance claims and the approach to be taken. The evidence should be assessed with a solicitor to ensure the correct tactics and proceedings are used to handle the claim.

In addition to the standard considerations which need to be made in an action for misfeasance under Section 212, thought must be given to the standing of HMRC, and it is likely their inclusion will need to be made sooner rather than later.

If you are aware of a company’s tax avoidance use, it is critical that the correct professional advice is taken in order to resolve the issues discussed above in a timely manner.

 

This article was a joint collaboration between myself and Lauren Tennant who is a Forensic Services Executive at Tait Walker

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