Additional Realisations: How investigations induce settlements in tax avoidance cases

With the release of the Paradise Papers, the spotlight has shone on high profile abuses of tax legislation. This is where individuals subvert the letter of the law to reduce their personal tax position, often in the sum of hundreds of thousands of pounds.

These transactions are artificial and highly contrived, serving no 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. These are known as tax avoidance schemes. They get scheme reference numbers under HMRC’s Disclosure of Tax Avoidance Schemes (‘DOTAS’) regime. HMRC has not approved these schemes.

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 is never repaid. These transferred funds are deemed ‘‘disguised remuneration’’. The employer company incurs an additional tax liability on the unpaid PAYE and NIC on the remuneration paid into the scheme.

Schemes that 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, as it’s received in the form of loans rather than income. However, renaming the receipt does not change the reality that income has been distributed from a company without being subject to the correct tax.

Insolvency

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

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. Recent publications from HMRC show that liquidators should be looking out for 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’. It estimated that in 2015/16, as a direct result of tax avoidance schemes, 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). This evidences HMRC’s strong commitment to reducing tax avoidance and holding users of historic tax avoidance schemes accountable for the strategies employed.

As announced in the Autumn 2017 Budget, HMRC will invest an additional £155 million 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”). Using an unapproved scheme in order to avoid tax liabilities is quite clearly a retention of crown monies. There are also possible preference payments, transactions at undervalue and putting assets out of the reach of creditors.

A director who has personally benefited from the abuse of an unapproved scheme could find themselves on the HMRC “Hit List”. They could 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 for the insolvent company by a director. This is 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 high, as it can be proven that company directors have personally benefited from receipt of funds from tax avoidance entities. This shows that their personal asset base is sufficient to fund a potential settlement to the liquidation estate.

It is important for liquidators to 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. Therefore, a company wound up prior to the implementation of the new Loan Charge 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.

An electronic review of company bank statements and base records can identify personal assets and accounts of the directors 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. This achieves significant realisations for the benefit of creditors and assists with cost recovery for the estate.

Forensic investigations can assist with:

  • Quantifying amounts paid into avoidance schemes
  • Unravelling complex offshore trust structures
  • Reviewing Trust Documents and scheme information
  • Reviewing automated bank transaction 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

It is important for an insolvency practitioner to evaluate their options after the investigatory side has taken place. This is with regards to any potential misfeasance claims and the future approach. A solicitor should assess the evidence to ensure the correct tactics and proceedings in handling 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. It is likely their inclusion will need to be made sooner rather than later.

It is critical to take the correct professional advice if you are aware of a company’s tax avoidance. This is in order to resolve the above issues in a timely manner.

Joint article written by Lauren Tennant, Tait Walker and Michael Stevens of TBI law.