On 11 April 2018 the government published a discussion paper in which it seeks views on how to tackle tax payers who seek to avoid or evade their tax liabilities through the misuse of the insolvency regime including phoenixism.
The government has identified that there is a small minority of company directors who use tax avoidance schemes, are guilty of tax evasion and repeatedly cause their companies to fail to pay their tax enabling the directors to extract money from the company for their personal benefit. When HMRC catches up with these companies/individuals and raises assessments and/or Accelerated Payment Notices, the directors place the companies into liquidation, leaving the tax liabilities behind and often set up phoenix companies where the same behaviour is repeated.
HMRC currently has limited powers to transfer liability for unpaid corporate tax to the directors and officers personally, but these powers are not consistent across all taxes. The government has therefore identified that this behaviour could be tackled by extending these powers more widely and
- extending HMRC’s powers to recover tax from those persons responsible for the tax avoidance or evasion, where those responsible are not the directors/officers, and
- allowing HMRC to hold those responsible for the tax avoidance/evasion jointly and severally liable for the tax debt if the company is unable to pay it.
It is suggested that HMRC be entitled to use these enhanced powers whether or not the company has entered a formal insolvency process.
No-one could seriously argue against the principle that every individual and company should pay its taxes as these are used to fund vital public services. However, there is an argument that should HMRC be granted these enhanced powers, it would have an unfair advantage over the general body of unsecured creditors in the event of a formal insolvency process.
Prior to the coming into force of the Enterprise Act 2002, HMRC had preferential status in respect of a range of tax liabilities in the event of a formal insolvency. This meant in the event of a distribution by the office holder, for qualifying tax debts HMRC ranked higher in the order of priory than the holders of floating charges and the general body of unsecured creditors. However, the government at that time decided to remove this preferential status, leaving HMRC to rank alongside the unsecured creditors.
So, whilst measures to recover tax from those responsible for tax avoidance and evasion are to be applauded, is it right that these powers be given to HMRC because to do so would appear to place HMRC at a significant advantage over the unsecured creditors? This would appear to represent a reversal of government policy introduced by the Enterprise Act 2002. HMRC would clearly argue, as they always have, that they are an involuntary creditor whereas trade creditors have the option to set credit limits and decline to provide goods and services when the credit limit is exceeded. Furthermore, if the tax had been paid the funds would not have been in the company bank account and available for payment to suppliers prior to formal insolvency or by way of a dividend post insolvency, so unsecured creditors are no worse off.
The other side to that argument is that the pari passu principle, whereby all assets are distributed equally amongst creditors according to the prescribed order of priority, has always been fundamental to the way in which UK insolvency legislation has been drafted and applied. Insolvency office holders are given wide ranging powers under the Insolvency Act 1986 to challenge the conduct of de jure, de facto and shadow directors in the months and years leading to the commencement of formal insolvency. Any sums recovered are then distributed equally amongst creditors in the prescribed order of priority. If HMRC is granted the enhanced powers referred to above, the risk is that in some cases they could end up competing with the insolvency office holder to recover monies from the same individuals. If HMRC wins that race, regardless of the merits of the office holder’s claim, that claim may end up being abandoned due to a lack of certainly as to whether sufficient assets remain against which to enforce judgment. Certainly, if these enhanced powers come into force, I can see that third party litigation funders will be adding this issue to the list of enquires they make when undertaking their due diligence in response to applications to fund office holder claims.
Perhaps the solution to this potential problem is that in the event of a formal insolvency, enhanced powers be granted to the office holder, with assistance from HMRC, to recover tax liabilities from those responsible for tax avoidance or evasion, with any recovery being paid into the insolvent estate. Clearly HMRC will have deeper pockets with which to fund such action but third party litigation funding would be an option for the office holder. Alternatively, the enhanced powers could be granted to HMRC as proposed but with any recovery being paid to the insolvency office holder.
The government invites comments upon the discussion document by 20 June 2018.