Overview Of Tax Avoidance Liquidation Claim Fails
Tax Avoidance Liquidation Claim Fails arises from the matter of Asertis Ltd v Heathcote & Anor [2022] EWHC 2498 (Ch).
The company Servico Build Tec Limited (“the Company”) went into Creditors Voluntary Liquidation.
The main feature of the case related to two substantial reward payments made to the Company’s Director of around £500,000 (“the Reward Payments”) through a tax avoidance scheme. Although there was another preference claim of £65,000 which succeeded the bigger claim was lost.
The claim had been assigned by the Liquidator to a litigation funder. It was a breach of duty action:
In summary, the claimant contends that the rewards: (a) were neither authorised nor justifiable as remuneration to Mr Heathcote for his services as director and had no other proper basis and, thus, made in breach of his duties to the Company as its director; and/or (b) represented transactions at an undervalue defrauding creditors under s.423 of the Insolvency Act 1986; and/or (c) were made in breach of what is commonly referred to as the insolvency or creditors’ interests duty.
There were board minutes that suggested that the Reward Payments were not remuneration. The Court rejected those documents largely because they were created some three years later but still accepted the Director’s position that the Reward Payments were a form of remuneration and were good consideration for the Director’s contribution to the Company.
The court considered whether there was a creditor interest consideration required before the Reward Payments could be advanced under the tax avoidance scheme in light of any solvency issues.
Reason The Misfeasance Claim Failed
What was interesting was the reasons given by the Court as to why this aspect of the claim failed. In particular the assessment of when the Company was insolvent and whether a transaction can be reconsidered as something other than what it was recorded as in the books and records:
The first question is whether the creditors’ duty arose at the time of the first and the second rewards, i.e. in October 2014 and in October 2015.
It is common ground and clear that, if no account is taken of the potential additional tax liabilities arising in the event that HMRC successfully challenged the EBT Scheme and thus established that the rewards were subject to PAYE/NIC, the Company was solvent at both dates. The experts agreed that: “On the face of it, Servico was both solvent and a going concern on both dates. It is a matter for judicial determination whether Mr Heathcote might and perhaps should have “taken into account” the overwhelming contingent liabilities arising under the Scheme (using the terminology of IA 1986, s123(2))”.
As is well known, and as is summarised above, s123(2) of the Insolvency Act 1986 provides that: “A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities”.
A question which was not investigated or argued before me, but which I raised briefly in closing submissions, was whether the Company’s liability to HMRC for PAYE/NIC was an actual or a contingent or prospective liability. The curious feature of this case is that although HMRC has – as already discussed – served final proof of debt claims against the Company there has been no final determination of those claims and it has not, so far as I have been made aware, been authoritatively determined that the Qubic EBT Scheme, whether in the form advised or in the form implemented by the Company if different, is ineffective to produce its intended legal result so that a company in the position of the Company is liable to account for PAYE/NIC on the value of such rewards. That, presumably, is because the implementation of the 2019 Loan Charge Rules has rendered the question academic in this (and probably other) cases, since Mr Heathcote is personally liable to HMRC under those Rules for the amount of the PAYE/NIC regardless of any liability on the part of the Company.
Sensibly, Mr Cochran did not urge me to decide this point from scratch, not least because both counsel had proceeded on the basis that the real question was whether or not the Company was balance-sheet insolvent at the material times, applying the approach in Eurosail referred to above, where the court is required to “make a judgment whether it has been established that, looking at the Company’s assets and making proper allowance for its prospective and contingent liabilities, it cannot reasonably be expected to be able to meet those liabilities. If so, it will be deemed insolvent although it is currently able to pay its debts as they fall due. The more distant the liabilities, the harder this will be to establish”.
Beginning with YE 31 Oct 2014, I have already summarised the Company’s financial position as set out in the accounts and also set out the worst case scenario, from which it is clear that if the potential additional tax liability had materialised at that time both for YE 31 Oct 2013 and YE 31 Oct 2014 there would have been no prospect of it being repaid, given a combined total liability of around £579,000 (i.e. £315,000 and £264,000 respectively), compared to shareholder funds of around £220,000, producing a shortfall of around £359,000. Even if one adds back to shareholder funds the dividend actually declared and paid of around £58,000 (as I think is reasonable on this hypothesis, since it would have been reasonable for Mr Heathcote to proceed on the basis, when considering the Company’s financial position at the time and before declaring a dividend that this amount was included in the funds available to the Company), producing an available amount of around £278,000, that would still leave an substantial shortfall of over £300,000.
By comparison, if, as a result of a challenge by HMRC, the Company had proposed and HMRC had agreed that the transaction could be reversed and lawfully treated as dividend, the total liability for corporation tax would have been in the region of £145,000 for both years, which the Company could have afforded to pay off relatively easily. If, as Mr Kitson agreed, HMRC would usually have been willing to negotiate a settlement so long as the Company approached matters constructively, the Company had immediately available substantial funds and a reasonable prospect of adding to those funds through profits made in forthcoming years.
It is also worth noting that on the basis of the recent final proof of debt figures the actual PAYE/NIC liability for YE 31 Oct 2013 (net of interest) is only £196,215 and the figure for YE 31 Oct 2014 (net of interest) is only £157,490, thus a combined total of £353,705, compared to available funds of around £278,000. It is reasonable to proceed on the basis that this is HMRC’s genuine assessment, which gives credit for the corporation tax saving identified by Mr Tesciuba, and that there is no obvious reason as to why it would not also have been its assessment had it made such an assessment at that time.
The same essential parameters apply to YE 31 Oct 2015, although by this point the potential total additional tax liability had increased by around £247,000 to around £826,000 and, in contrast, only around £254,000 shareholder funds were available and, even adding back the dividend actually declared and paid, still only around £304,000. By contrast, the total liability if converted to dividend would have been in the region of £195,000, so that the Company could still have afforded to pay this sum. The prospects of negotiating a settlement were still present, although of course more challenging. Taking the actual figures now claimed by HMRC the additional tax liability rises by £145,880 to £499,585, compared to available funds of around £304,000.
Without an in-depth analysis of the tax position and/or expert advice from a tax specialist as to the likely advice which would have been given had one been consulted at the time it is very difficult if not impossible to put any precise contemporaneous assessment on the likelihood of a challenge being made and being successful, or of HMRC introducing retrospective legislation which would have imposed the additional tax liability on the Company in any event, or of the prospects of the Company successfully negotiating with HMRC an agreement under which it would only have to pay a charge based solely on the corporation tax payable by the Company on dividend or, alternatively, a reduced settlement figure for the total PAYE/NIC liability with time to pay.
In my judgment however, taking (as I think is reasonable) the actual figures contained in the most recent final proof of debt, factoring in what was at least a reasonable prospect of the Company being able and HMRC being willing to treat the rewards as dividend, and factoring in HMRC’s usual willingness in the case of a viable trading business to agree a reasonable staged payment schedule rather than driving such a business into liquidation, I do not think that as at either October 2014 or October 2015 the Company had clearly been demonstrated to have been insolvent on a balance sheet basis.
In reaching this conclusion I have taken into account, in addition to the evidence referred to above: (a) the absence of any evidence of any contemporaneous challenge at this time by HMRC, whether to this company’s adoption of the Qubic EBT Scheme or to the Qubic EBT Scheme more generally; (b) the absence of any enquiry having been opened by HMRC into the relevant tax returns over the relevant periods; and (c) the absence of any evidence that HMRC had already signalled its intention to introduce retrospective legislation which would render the Company liable for the additional tax liability regardless of the success or otherwise of any challenge to the scheme under the existing law.
Finally, I bear in mind that, under the law as stated by the Court of Appeal in Sequana, I would need to be satisfied that at the relevant times the Company was either insolvent or probably going to become insolvent. Here, the fact that the Company was able to carry on business for another three years after the final reward was provided militates against a suggestion that Mr Heathcote knew, or ought to have known, that the Company was, or was probably going to become, insolvent either as at October 2014 or as at October 2015.
In the circumstances I do not need to consider whether or not Mr Heathcote breached that duty, if it had been engaged. However, if I had decided that the duty was engaged that can only have been on the basis that I was satisfied that the prospect of the Company coming under a liability to pay the additional tax liability was so significant that no reasonable director could have ignored and made no provision against that risk. The only obvious way in which that could properly have been done was to ensure that sufficient funds were retained in the Company to pay in the event of a challenge. That does not mean that no payment at all could have been made, only that the payment would have needed to be reduced to allow sufficient funds to be retained to meet any additional tax liability. Working on a fairly rough and ready basis, in the YE 31 Oct 2014 an additional tax liability of £157,490 is now claimed on a payment of £270,000 and in the YE 31 Oct 2015 an additional tax liability of £145,880 is now claimed on a payment of £250,000. In effect, the additional tax liability is approximately 60% of the payment made. It would appear to follow that the Company could, properly, have paid approximately £170,000 in YE 31 Oct 2014 and approximately £160,000 in YE 31 Oct 2015 whilst leaving more than sufficient to guard against any additional tax liability arsing from those payments. On that basis, the breach would lie in paying an additional £100,000 in the first year and an additional £90,000 in the second year. Whilst I appreciate that this is less than Mr Tesciuba’s worst-case scenario, I do not think that it is either realistic or reasonable to find that this amount could and should have been retained, bearing in mind the totality of the evidence, including what has actually been assessed.
In a case like this, where it is apparent from the evidence that no proper thought was given by Mr Heathcote to the risk of paying as much as the Company did in relation to the reward, the court has to apply an objective test. In the circumstances I would have been satisfied that Mr Heathcote had breached this duty by causing the Company to pay the full rather than the net amount to procure the rewards.
Oliver Elliot Observation
A notable feature of this case was the assessment of insolvency for the purposes of considering the creditors interest duty as follows:
In my judgment however, taking (as I think is reasonable) the actual figures contained in the most recent final proof of debt, factoring in what was at least a reasonable prospect of the Company being able and HMRC being willing to treat the rewards as dividend, and factoring in HMRC’s usual willingness in the case of a viable trading business to agree a reasonable staged payment schedule rather than driving such a business into liquidation, I do not think that as at either October 2014 or October 2015 the Company had clearly been demonstrated to have been insolvent on a balance sheet basis.
The Court engaged in an assessment of insolvency that appears to have injected some element of speculation into its reasoning and also has applied its mind to the reversal of transactions. Consideration of reversal of the substance of a transaction of a remuneration-type nature was perhaps notable when contrasted with what another Court has said about changing history which can be seen in an earlier Oliver Elliot post called Can You Backdate Your Salary? when it said:
In my judgment, it is simply not open to a director to recreate history and the basis upon which they have historically received money from a company.
If it is not open for a Director to recreate history from the vantage point of company law is it open to do so from the vista of tax law?
This Judgment if widely followed may impose further features upon claimants to grapple with when coming to an assessment of cash flow insolvency.
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