Since 22 July 2020 the Finance Act has empowered HMRC to make directors personally liable for the tax debts of a company in liquidation or potential liquidation where they are suspected of abusing the insolvency framework in order to avoid paying taxes.
It does this by allowing HMRC to give joint and several liability notices to directors and certain other individuals connected to a company for amounts the company owes to HMRC. However, the legislation only applies to liabilities relating to a period that ends on or after 22 July 2020.
Why is there new law?
The purpose of this new law is to deter the use of insolvency as a way of tax avoidance or evasion. It is also aimed at addressing situations where individuals and companies repeatedly fail to meet tax liabilities through insolvency. Phoenixism has been a known concern for creditors for some time. This is where a company is liquidated only for the same business to re-emerge from the ashes as a fresh entity, thereby avoiding debts to various parties including HMRC. The authorities want to discourage this behaviour.
The response – HMRC notices
Where HMRC believes that a company is insolvent or about to become insolvent, and the amount it owes HMRC will not be paid, it may give a notice making an individual (or several individuals) jointly and severally liable with that company for these tax liabilities. These individuals may be or have been directors, shadow directors (with whose instructions directors are accustomed to act) or participators with an interest in the capital or income of the company.
What is “joint and several liability”?
Joint and several liability means that an obligation may be enforced in full against any or all of the jointly liable parties. All the individuals given a notice will be jointly and severally liable with the company for paying tax liabilities. This means that any one of them may be pursued for all or part the amount owed to HMRC.
When will HMRC use this new power?
There are three circumstances in which a joint and several liability notice may be given, as follows:
- Companies which have engaged in tax avoidance or tax evasion and HMRC believes there is a risk that their tax liability will not be paid due to insolvency.
- Individuals who have been involved repeatedly with companies who have become insolvent without outstanding tax liabilities with HMRC.
There are four conditions which must be met before a notice will be issued:
- The individual must have had a relevant connection to at least two other companies (old companies) which were subject to an insolvency procedure and had a tax liability
- A “new company” is or has been carrying on a similar trade to any of the old companies.
- The individual must have a connection to the new company
- The relevant old companies must have a tax liability of more than £10,000 and that is more than 50% of the total amount of those companies’ liabilities to their unsecured creditors.
- Individuals who have been connected with a company that has facilitated tax avoidance or tax evasion by others and becomes or may become insolvent.
The purpose of the guidance
Prior to the new law taking effect, many interested groups expressed concern that the breadth of the legislation could mean that it applies more widely than intended, inhibiting certain sound business initiatives. Some of these concerns were addressed in the final legislation, but others were not.
In order to reduce uncertainty over the application of joint and several liability notices, HMRC said that it would issue a guidance about this new power to explain who it is intended to apply to, and how and when it will use these notices. This guidance was recently published. Whilst this provides some clarification, there remain certain areas of concern which all those connected with insolvencies or potential insolvencies should be aware of.
Members’ voluntary liquidations – acknowledged but still exposed
HMRC recognises that the legislation is not intended to impact a genuine members’ voluntary liquidation (MVL), which remains a legitimate way of closing a solvent company. However, if all a company’s tax liabilities are not paid within 12 months of the start of its winding up process, joint and several notices may be issued to individuals with the relevant connections where repeated insolvency is suspected. Many debts in MVLs are not paid within 12 months for genuine reasons. So, where this is the case, and the company falls within the criteria for the HMRC notice, it will be important to pre-empt such a notice by contacting HMRC to explain the situation.
Turnaround specialists – to be judged case by case
Similarly, the HMRC guidance recognises the importance of “turnaround specialists” who attempt to rescue companies on the verge of insolvency but, by the nature of their work, may be linked to various corporate insolvencies. HMRC does not want to inadvertently issue a notice against such individuals, however it apparently intends to decide about applicability on a case by case basis. The onus therefore seems to be on such specialists to anticipate HMRC scrutiny, and to provide relevant evidence of attempts to save a company that is ultimately liquidated.
New laws and powers may improve overall insolvency and corporate governance frameworks, but, in this case, they also increase directors’ risk. Keeping up to date and understanding the implications of the latest developments is therefore vital.