Tax avoidance, insolvency and personal liability

This article was originally published in the June 2022 issue of Sports law and taxation magazine.

In recent times, tax avoidance has come to the fore as a contributory factor for global financial crises. In the UK (and other jurisdictions), tax avoidance structures have been tested by the courts and found to have been artificial and in place for the purposes of avoiding tax. HMRC is following up with individuals affected by these cases and is issuing assessments to recover tax that was ‘avoided’ by the use of such arrangements or schemes.

Key considerations arising for users of these arrangements are
• whether the fact they were given advice in relation to the avoidance arrangements can be used to mitigate penalties; and
• if the tax liability and penalties result in a company going insolvent, would winding up the entity mean that the tax liabilities are no longer payable?

The latter point becomes a consideration regardless of whether there was any tax avoidance.
In this post-CoVid world, governments have withdrawn financial support and businesses all over the world are struggling to reach pre-pandemic levels of turnover (though arguably, the UK is one of the worst hit). In these situations, insolvency may be the only way forward. The question remains though – what happens to any outstanding tax debts?

International HNWIs have routinely been advised to set up overseas companies to take payment for image rights or other exploitation of the individual’s public image. The structures implemented vary and can include trusts as well. The prevailing opinion in the UK currently is that where a structure is implemented with the sole (or sometimes main) purpose of reducing a tax liability, this is aggressive tax avoidance and the structure can be looked through to tax the individual. This can be particularly problematic if an individual has become tax resident in the UK (perhaps due to CoVid, though some exceptions will apply) and has benefited from overseas structures while here.

As a result of the prevailing ‘opinion’ and to avoid public tribunal hearings in future, people may be looking to wind up structures. Before doing so however, advisers should be aware of possible UK tax implications.

How much reliance can you place on your tax adviser?

This question has become topical for taxpayers, since Mr Andrew Thornhill QC was sued by the users of tax avoidance schemes on the basis that he had reviewed the arrangements and stated they would confer a tax advantage. The court reviewing the case stated that the barrister “did not owe any duty of care to the schemes’ investors”1. The full decision can be read here.

The basis of the decision was that Mr Thornhill was instructed by Scotts, promoters of the schemes, to advise on the tax implications of the arrangements. He was never instructed by any of the claimants and in signing the agreement to invest, the taxpayers had also confirmed that “it was, and is, my responsibility to obtain appropriate advice, recommendations and assessment, as referred to above, from an independent financial adviser or other suitably qualified person.” This means that the investors who relied on Mr Thornhill’s analysis on the basis that he was Scotts’ adviser are now realising almost 20 years on that they were not entitled to do so.

One of the points the judge made was that the investors were business people and they had a certain level of knowledge in relation to finance and tax. They were not solely reliant on the advice from Mr Thornhill. We cannot say whether the judge’s decision would have been different had the investors been (e.g.) laypeople or whether this was simply mentioned to support his decision.

HNWIs will typically be regarded as being more financially sophisticated than laypeople, if only by virtue of having more money and having more complex structures (regardless of whether or not they understand them). This result unfortunately supports HMRC’s case that taxpayers cannot be said to have taken reasonable care if they didn’t take separate advice, addressed directly to the taxpayer and which was specific to the taxpayer’s own affairs.

It also raises the question of when taxpayers should be aware of when the advice or opinion they are relying on is or is not sufficient. This is ironic considering people tend to rely on advice from a professional when they are not sure what the position is in the first place! How one is meant to identify – based on little to no understanding of the issues at hand – whether the advice is correct or dependable is confusing at best. HNWIs have more money at stake than most when entering into tax planning and should ensure they obtain independent advice from trusted adviser who is not part of the arrangements being suggested.

Implications of not taking separate advice

If tax avoidance arrangements are found not to work, not only are the investors required to pay taxes found to be due, but there is also the potential for penalties to apply. The media are happy to write about celebrity or wealthy individuals having to repay HMRC for use of Tax Avoidance Schemes. Those in the public eye therefore run the risk not only of higher penalties, but also of reputational damage. This is more likely to affect celebrities who rely on public endorsement than those who are multi-national business enterprises and is a point to consider should Tax Tribunal become an option.

Penalties are a standard amount within certain threshold depending on whether a taxpayer was careless or deliberately filed an incorrect return. Where a taxpayer took reasonable care, penalties are £nil. Until relatively recently, “reasonable care” included taking advice from a tax professional. Now, the UK tax legislation is such that reliance on an adviser or reliance on advice is not counted as a “reasonable excuse” if the advice is “disqualified” or is “provided by a certain interested person” (i.e. someone who stands to benefit if the taxpayer takes part in the arrangements).

Unfortunately, the legislation applies at the time penalties are considered, rather than looking at the applicable legislation at the time the arrangements were entered into (i.e. the time that the advice was taken/given). HMRC are applying penalties for inaccurate returns on this basis and clients should be made aware of the potential impact on their total liability.

A number of other cases have been through the UK courts in relation to whether an individual has taken reasonable care if they relied on their adviser and the outcome of these are very mixed. In the cases where reliance on an adviser was sufficient, the individual showed that they took an active role as far as possible to ensure their tax affairs were in order, including chasing the adviser for documentation, and double checking their understanding. In other cases the taxpayer won because at Tribunal, their lack of financial understanding was so clear, reliance on an adviser was the only option they had. As mentioned above, the bar for HNWIs and business owners to demonstrate reasonable excuse on the basis of reliance on an adviser will be that much higher.

Personal Liability Notices

One of the benefits of a company or other incorporated entity is that it shields individuals from being held liable should there be any lawsuits or other debts incurred by the company (and outstanding when the company becomes insolvent). Where a company is investigated and found to have underpaid certain taxes, HMRC may, providing specific conditions are met, transfer the liability for paying the outstanding taxes (and penalties) to “liable officers” of the company.

The legislation pierces the corporate veil and allows HMRC to hold Directors of a company personally liable for corporate debts. A general rule is that HMRC must demonstrate that the Director(s) deliberately did not pay the relevant taxes to HMRC. In some cases however (e.g. VAT fraud by a third party), no such proof is required. Here we are only looking at PLNs in relation to tax avoidance and insolvency however HMRC does have powers to shift a corporate liability to Directors in a number of other cases.

Recent legislation has widened the powers in relation to the use of tax avoidance arrangements and insolvency and tax advisers may find themselves working with insolvency practitioners in this regard. For these situations, understanding the client’s and HMRC’s position before entering into insolvency is key.

In this article, reference to a “Director” includes any company officer or anyone managing a company’s affairs (to avoid confusion with HMRC officers).

Tax avoidance and insolvency (Sch 13, Finance Act 2020)

In Finance Act 2020, legislation was enacted to allow HMRC to shift outstanding tax debts for an insolvent (or likely to be insolvent) company onto the directors providing the following conditions are met:

• the company has committed tax evasion or entered into tax-avoidance arrangements from which a tax liability has arisen or is likely to arise;
• the company is insolvent or there is a serious possibility of the company becoming insolvent;
• some or all the tax may not be paid;
  and
• the individual(s) receiving the notice were responsible for the company entering into the relevant transactions, or knowingly received a benefit from the arrangements when they were director(s); or
• the individual(s) took part in, assisted with or facilitated the tax-avoidance arrangements or the tax-evasive conduct when the individual was managing the company.

The Director(s) receiving the notice is jointly and severally liable with the company for the relevant tax liability.

On issuing a notice, the HMRC must justify why it believes the conditions were met. Thus if a taxpayer receives the notice but considers that any of the above points are not in play, they can request clarification from HMRC. If the taxpayer still disagrees with HMRC’s conclusion (or even if no review was requested), they can also appeal to Tribunal.

When requesting a review of the notice from HMRC, the taxpayer cannot “challenge the existence or amount of any tax liability of a company to which the joint liability notice…relates” (para12(5) and para14(2)) unless the company is going insolvent and therefore has not appealed.

HMRC has 45 days to issue the result of their review with reasons for the conclusion. If HMRC does not respond, the notice is treated as upheld (para12(9)) and HMRC must notify the individual (but there are no time limits within which HMRC must do so).

There are also additional powers for HMRC to issue a Joint and Several liability notice where an individual who has been director of more than one company that has become insolvent within the previous five years with outstanding debts to HMRC, is director of a new company, which is carrying on broadly the same business as two (or more) previous companies.

The legislation does not require consideration of whether there has been any misfeasance, it is enough for the Director(s) to be responsible for the company entering into the arrangements. In Hunt v Balfour-Lynn and Ors, the high court found that the Directors had not been guilty of misfeasance despite having known HMRC’s views on the tax avoidance arrangements since 2005 and continuing to pay themselves a dividend based on the after tax profits taking into account the avoidance arrangements. We understand that the decision is being appealed.

Thus at present, even if courts find in insolvency cases that the implementation of tax avoidance schemes was not mismanagement, HMRC can still pursue Directors personally.

Legislation for repayment of incorrectly claimed Coronavirus Support payments applies the same rules for transferring the liability to Director(s) as for the Tax Avoidance Joint and Several liability notices (para 15).
If the company is likely to become insolvent, is liable to repay any of the coronavirus support payment claimed and the Director(s) of the company knew that the company was not entitled to the coronavirus support payment repayable and it is likely that the tax liability will not be paid, then HMRC can issue a joint and several liability notice to Director(s) of the relevant company.

Again reputationally, it does not look good where a business owned by a celebrity has claimed Corona Virus support payments and then goes into liquidation owing taxes. In my opinion, HMRC will not hesitate to capitalise on this and will use the legislation to claw back the money.

Notification of uncertain tax treatment

Finance Act 2022 includes a Schedule on the Notification of Uncertain Tax Treatment where companies or partnerships with a UK turnover of more than £200m and/or a UK balance sheet total greater than or equal to £2bn must notify HMRC if they are implementing any arrangements where it is likely HMRC would take a different view of the transaction(s) i.e. where the tax liability is an ‘uncertain amount’.

The legislation defines an uncertain amount as one in relation to which a “provision has been recognised in the accounts of the company, or a member of the partnership, to reflect the probability that a different tax treatment will be applied to a transaction to which the amount relates” and/or “the tax treatment applied in arriving at the amount relies (wholly or in part) on an interpretation or application of the law that is not in accordance with the way in which it is known that HMRC would interpret or apply the law.”

Helpfully, we are told that “HMRC’s position on a matter is taken to be “known” by a company or partnership if it is apparent from—
(a) guidance, statements or other material of HMRC that is of general application and in the public domain, or
(b) dealings with HMRC by or in respect of the company or partnership (whether or not they concern the amount in question or the transaction to which the amount relates).”

Given that HMRC has previously stated in court that their guidance cannot be relied upon2 as it is simply HMRC’s interpretation and may not be a correct analysis of the legislation, it will be interesting to see whether the NUTT legislation can be used to support taxpayers’ position in other areas.

Conditions for notification to be required

An uncertain amount does not need to be reported to HMRC if (s8(4))

• the tax advantage obtained is £5m or less (s11(2)) (this applies across the group if the transactions are intra-group (s19));
• the business is subject to an exemption because “it is reasonable for the company or partnership to conclude that HMRC already has available to it all, or substantially all, of the information relating to that amount that would have been included in the notification if it had been required to be given.” (s18).3 If a business intends to use this exemption, it would be advisable to keep a record of the reasoning, including why the directors/partners consider HMRC has sufficient information.
• The tax advantage is the difference between the uncertain amount and the expected amount, i.e. the tax that would be due if it were found that the uncertain tax treatment does not work.

Penalties for non-compliance

If a body fails to notify HMRC of an uncertain amount then the penalty is £5,000. If there is another failure to notify and within the previous three accounting periods, the first penalty has been levied, then the next penalty is £25,000. Further failures are penalised at £50,000 where in the previous three accounting periods, the body was assessed to a penalty of £25,000 or £50,000.

The legislation provides a number of definitions (including related amounts, notification deadlines, relevant periods, tax advantage in relation to the different taxes) which we do not go into here. The key is simply to be aware of this legislation for any large businesses. If there are any concerns about the tax treatment, then you would need to go back to Sch 17, Finance Act 2022 and identify whether a notification needs to be made.

We suggest that notifications are made as part of the whitespace in the relevant tax return, keeping aware of the recent case Victoria Carter & Peter Kennedy v HMRC [2021] UKUT 300 (TCC). the information in the whitespace must provide sufficient information for HMRC to determine the depth of the possible issue, otherwise it is worthless.

What can clients do?

For structures that were implemented in the past, clients should remember that advice is only valid if it is current and takes into account their specific circumstances. They are advised therefore to routinely (I would suggest annually, especially for more complex planning) request a review of previous advice, from an independent adviser, to confirm that the advice is valid and/or that the structure in place still produces the expected result. The review should be undertaken bearing in mind any legislation changes since the advice was first provided, together with a consideration of changes in best practice and HMRC’s current approach.

For transactions undertaken in future, advisers should review HMRC published material and not only refer to it in their advice to clients but also take copies of it, in case of future changes. Should there be a future challange, advisers will need to demonstrate that any planning advice given was in line with the legislation and within the bounds of what HMRC accepted at the time the transaction or structure was implemented.

In the UK, we sadly seem to be going away from looking at the legislation and having the court test ‘what parliament intended’ to HMRC defining what it believes parliament intended and basing investigation on its belief. This is a worrying state of affairs and HNWIs should be warned – anything but the most vanilla of transactions could come under scrutinty if not now, then anytime in the following twelve years.

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