HMRC discussion document on tax abuse and insolvency
The practice of ‘phoenixing’ or ‘phoenixism’ involves carrying on the same business or trade successively through a series of limited liability entities (usually companies) where each becomes insolvent in turn. Each time this happens, the insolvent entity’s business, but not its debts, is transferred to a new ‘phoenix’ entity.
From HMRC’s perspective, phoenixism involves the running up of tax liabilities in a company, then avoiding making payment by making the company insolvent. A new company is then set up by the same person who owned the insolvent company, which will then acquire the assets of the old company, sometimes at less than their full value, so as to increase the benefit to the person(s) driving these actions. This creates unfair commercial advantages.
Phoenixism is unfair to all those creditors who go unpaid even if the insolvent company’s business continues, but bites harder for HMRC. In many instances, creditors other than HMRC will be paid by the new company in order to secure ongoing supplies and ensure that the business can continue in the new company.
Workers can also be affected when their employer goes into liquidation. If PAYE and NIC have been deducted from their earnings but not paid over to HMRC by the company, this could affect their personal record of NIC contributions impacting on certain entitlements.
Whilst HMRC has some powers to address attempts to abuse the insolvency rules to avoid paying tax, they are not uniformed. For example, if an insolvent company is found to have deliberately underpaid Corporation Tax and Excise duties, HMRC can transfer liability of the Excise duty penalties to the insolvent company’s directors, but not the Corporation Tax.
Avoidance, evasion and insolvency
Some people who are involved in tax avoidance, tax evasion, or repeated non-payment, seek to misuse insolvency in an attempt to swerve their tax liabilities at the point they are rumbled by HMRC. They might do this in a number of ways, for instance:
·the controlling director/shareholder uses tax avoidance or tax evasion to extract value from a company;
·the company accumulates tax debts but pays its suppliers to ensure their support so that the director/shareholder can continue the company’s business through a successor company if necessary;
·the company becomes insolvent, stripped of its assets with which to meet all its debts, often because those assets have disappeared in anticipation of the winding up;
·the controlling director/shareholder may continue acting in another guise, e.g. same trade, using the same customers/suppliers etc.
One of the challenges to HMRC in tackling this behaviour is how debts are established under the tax framework. Most creditors establish that a debt is owed to them when they invoice the company for the provision of goods or services. By contrast, there is usually a time difference between when the tax liability arises and when a debt is established by HMRC. This means that there is sufficient scope for a company to enter into insolvency after the tax liability has arisen but before the debt is enforceable.
HMRC does have the power to require high-risk businesses to provide an upfront security deposit, where it believes that there is a serious risk to the revenue. Security intervention is only considered in a small number of cases where there is clear evidence that a significant amount of revenue, relative to the size of the business, is at risk. In addition, there must either have been failure to comply with return filing and payment obligations, or the personnel actively involved in a current business must have been actively involved in another business that failed to pay the taxes that were due.
A separate consultation on extending the security deposit legislation to Corporation Tax and Construction Industry Scheme deductions was launched last month, and whilst complementary, this would not provide a full solution to the problem.
Insolvency practitioners are qualified persons who are licensed and authorised to act as office holders in relation to insolvency proceedings. They have a number of legal actions available to them to clawback assets from the director/shareholder and/or to impose personal liability on them for the company’s debts pursuant to the Insolvency Act 1986. However, pursuit of these proceedings is:
·reliant on the provision of information to the insolvency practitioner and/or HMRC;
·subject to litigation risk; and
·dependent on the insolvency practitioner’s appetite for such litigation.
As a result, even if proceedings are instigated they often end up in a “commercial” or discounted settlement being reached.
All of the above means that a controlling director/shareholder who chooses to misuse insolvency may receive a significant discount on the tax liability or pay nothing at all – enabling them to retain the fruits of tax avoidance, tax evasion and/or the commercial advantage of repeated non-payment.
In a bid to tackle the small minority of taxpayers who abuse the insolvency regime in trying to avoid or evade their tax liabilities in these ways, HMRC have recently published ‘Tax Abuse and Insolvency: A Discussion Document’.