May 12th 2020

Tax Avoidance and Directors’ Duties

“I hate paying taxes, but I love the civilization it gives me.”

US Supreme Court Justice, Oliver Wendall Holmes

Nobody enjoys paying tax, but it is a necessary evil. 
It is unfair to the general tax-paying population when directors of companies extract large sums, tax-free, via tax avoidance schemes, so triggering significant liabilities to HMRC which they assume will be buried on the liquidation of the company. 
Claims assigned to or funded by Manolete are often against former directors and in recent years breach of directors’ duties, in the context of tax avoidance, has been a recurring theme.
There are all sorts of weird and wonderful tax avoidance schemes out there, such as film schemes and gold bullion schemes, but the most common are the Employee Benefit Trusts (EBT) and the Employer-Financed Retirement Benefits Scheme (EFRB), both of which purport to reward and incentivise employees; with payments to the employee being free of income tax and NIC and the contributions into the scheme being deductible against Corporation Tax. They are disguised remuneration schemes. 
In the cases Manolete has financed, the typical scenario is payment of tax-free sums to the directors who are not employees, the schemes are heavily caveated and the directors warned the schemes may fail; and yet the directors pay themselves while making no provision for liabilities to HMRC.
Over a period of years, particularly from the late 1990s onwards, these schemes were aggressively promoted. Some of the promoter companies are themselves now in liquidation. Manolete has taken assignment and pursued claims against former directors of companies which promoted and provided tax avoidance schemes. These disguised remuneration schemes were and are of great concern to HMRC as income tax and NIC represent well over 40% of the UK’s tax revenue.
HMRC’s position was that disguised remuneration schemes did not work to avoid payment of income tax and NIC, but legislation appeared ineffective to deter use of the schemes with some courts and tax tribunals finding in favour of the companies seeking to avoid tax. 
It was not until 2015 and ultimately mid-2017 with the Supreme Court decision in the renowned Rangers case (RFC 2012 PLC (IN LIQUIDATION) V ADVOCATE GENERAL FOR SCOTLAND [2017] UKSC 45) that the correct interpretation of various long-standing legislation was applied to fundamentally inhibit the viability of the disguised remuneration scheme. The Supreme Court held that: 
i)    money paid into an EBT was intended to operate to give each employee access to the use of the money paid into the principle trust.
ii)    the money was to be treated as employee’s remuneration for employment and subject to tax.
iii)    the employer should have made the necessary deductions to pay HMRC.
Following Rangers, there is complete clarity that the disguised remuneration schemes don’t work and the employer company is liable to pay income tax and NIC.
So far, so good, but how does this impact on claims by a liquidator against the former directors of the company who have procured the company to enter into the failed schemes and who have paid themselves company cash tax-free?
A director is a fiduciary and he owes extensive duties under the Companies Act 2006 and at common law. The two most important duties, for the purpose of this discussion, are the duty to act with reasonable care, skill and diligence and the duty to act in good faith and in the best interests of the company. 
In many companies, the directors and shareholders are one and the same. This enables them, wearing their shareholder hat, to ratify the actions they take as directors, thereby providing a defence to a breach of duty claim under the Duomatic principle. However, when the company is insolvent or of doubtful solvency, such that the interests of the creditors intrude, the directors’ duties are owed to the creditors and any Duomatic defence falls away. 
Directors’ duties in relation to tax avoidance were considered by the Court for the first time in PV SOLAR SOLUTIONS LTD, BALL V HUGHES & WARE [2017] EWHC 2228 (Ch), where the liquidator was funded by Manolete. 
PV Solar supplied and installed solar panels, imported from China. There were two directors who were also the shareholders. The company had done rather well and the directors had rewarded themselves very handsomely through fees paid to their management companies. Things began to go downhill when the Government announced feed-in tariffs would be reduced and this had a detrimental effect on the business of the company.
The company entered into an EFRB scheme and through a series of paper transactions, sums totalling £758,000 were credited to the directors’ overdrawn loan accounts, thereby depriving the company of these assets. The company went into administration within two years of entering into the scheme and then into liquidation.
The liquidator advanced claims against the directors in misfeasance pursuant to s. 212 Insolvency Act 1986, in the alternative a claim that the payments into the scheme were void as transactions at an undervalue.
The directors defended the claims; they argued the credits to their account were in fact remuneration, the company was solvent when the sums were credited and as shareholders they could ratify the credits and had a Duomatic defence to any breach of duty claim.
The credits to the overdrawn loan accounts were made in three tranches and to succeed the liquidator had to satisfy the court the company was insolvent at the time of each credit, or of doubtful solvency such that the interests of the creditors intruded. This was most challenging on the first and earliest payment; there weren’t any unpaid creditors, but the directors had placed a large order with a Chinese supplier which was never paid, and which the directors knew could not be paid and, in all the circumstances Registrar Barber was satisfied the directors’ duties were owed to the creditors at the time of the first payment. 
The second credit was easier because by this time there were unpaid creditors, ironically one of those creditors being the promoter of the scheme OneE Tax Ltd. By the time of the third and final payment, there was clear evidence of insolvency and under cross-examination the director held up his hands on the third credit and said he couldn’t possibly defend it.
The directors sought to rely on the (then) recent decision at first instance in Global Corporate v Hale where the judge held dividends paid to the sole director and shareholder, which were challenged as being unlawful, were in fact remuneration rather than dividends, therefore they could not be recovered under s. 847 Companies Act 2006. The judge also held it would amount to unjust enrichment if the company did pay the director for services provided. The consensus was that Global was an unsafe decision and it was overturned on appeal (Global Corporate Ltd v Stefan Hale [2018] EWCA Civ 2618). 
In PV Solar, Registrar Barber preferred the decision in Guinness v Saunders [1990] 2 AC 663, which is authority that remuneration paid to a director, without the authority of the Board and in breach of the company’s articles, was repayable by the director.
Registrar Barber held that the directors’ duties were owed to the creditors of the company at the times when all the credits were made, that the directors had acted in breach of those duties and accordingly were liable pursuant to s. 212 to repay the £758,000 in full, together with compound interest and costs.
As the liquidator had succeeded under s. 212, Registrar Barber did not need to consider whether the credits amounted to transactions at undervalue.
This first consideration of directors’ duties, in the context of tax avoidance, indicated a robust judicial approach where directors have personally benefitted from such schemes to the detriment of creditors. There have since been two further important decisions.
In TOONE & PAOROU (as joint liquidators of Implement Consulting Ltd) v ROSS & BELL [2019] EWHC 2855 (Ch) the directors and shareholders set up an EBT in 2009 and a further EBT in 2010 (it is worth empathising this predated the Rangers decision by many years).
In 2009, the directors paid themselves £609,000 and a further £800,000 in 2010. They made no provision for PAYE or NIC. 
In 2011, HMRC contacted the directors - they knew the EBTs did not work and HMRC intended to raise substantial assessments. Instead of making provision for the liabilities to HMRC, the directors paid away a further £601,701 in 2012 under a third tax avoidance scheme.
The company went into liquidation with HMRC, the largest creditor, owed £1.7m.
The liquidator issued proceedings against the former directors claiming damages in breach of duty, alternatively that the payments under the schemes were unlawful distributions of capital.
Chief ICCJ Briggs held that:
i)    the payments made through the EBTs were distributions of capital and were unlawful because the formalities of Companies Act, with regard to payment of dividends, were not complied with.
ii)    tax became due and owing at the times the monies were paid into the EBTs; the liability accrues on the occurrence of the transaction giving rise to the taxable charge, the liability to tax is not contingent on the determination of a tax tribunal or court. A liability may be due without being payable. 
iii)    the failure to make provision for liability to HMRC was a breach of duty. 
The directors were ordered to pay £3m.
In ALLEN & CARTON-KELLY (as joint liquidators of Vining Sparks UK Ltd) v Bernard & Ors [2019] EWHC 2885 (Ch) the liquidators were unsuccessful, but it turns on its own particular facts and possibly the result might have been different had the claims not been so advanced as they were. 
Vining was the wholly-owned UK subsidiary of a US investment bank.
The directors changed the employee’s terms of employment and started to pay money into a remuneration trust. The arrangement was not about profit extraction, it was to enable UK sales employees to receive greater rewards without commensurate increase in cost to the US parent company.
In using the scheme and in continuing to do so until 2011, after HMRC had raised queries and made determinations of PAYE and NIC, the directors relied on the advice of the notorious Paul Baxendale Walker.
The scheme failed, Vining entered into liquidation and HMRC claimed £1.5m.
The liquidators issued proceedings against the former directors claiming:
i)    Breach of duty, and it was specifically pleaded that the directors had been dishonest
ii)    Further/alternatively, fraudulent trading
The US directors settled and the claim against the UK director proceeded to trial.
ICCJ Jones dismissed the liquidator’s claims in their entirety, finding the liquidators had come nowhere near to proving a case of dishonesty. The judge found the UK director to have acted honestly, believing the advice he had received to be sound; the director had acted in good faith.
The facts of Vining differ from those in PV Solar and Implement Consulting in that employees were actually paid via the schemes (not just the director) and the director took specific advice; that advice may have been wrong, but it was reasonable for the director to rely on it.
Claims of dishonesty and in fraudulent trading involve a high burden of proof.
IPs should not be deterred from bringing claims following the Vining judgment, particularly in the light of the Implement Consulting judgment. Manolete is certainly not deterred.
There has been an additional potential complication in these claims by HMRC making offers to settle directly with the directors under the loan charge. This can cause problems if such settlements result in HMRC withdrawing or massively reducing its claim in the liquidation. Further, there is the commercial reality to consider; if a director makes a payment in settlement to HMRC, would he have any money left to meet the claims of the liquidator or Manolete?
The Manolete approach has been to achieve a global settlement at mediation attended by all parties; HMRC, the directors, the IP and Manolete. The bottom line is usually the settlement sum needed to ensure HMRC receives a minimum dividend of a particular sum. Working with HMRC, Manolete has achieved seven-figure settlements on director tax avoidance breach of duty claims at mediation.
While not classic tax avoidance by entering into a formal scheme, Manolete has also supported claims where directors avoid VAT and other tax liabilities by suppressing sales.
In Manolete Partners v Siza, Mr Siza was sole director and shareholder of Palms Palace Ltd, which operated as a restaurant and Shisha bar. In May 2016, HMRC commenced an investigation in respect of suspected suppression of sales after the company’s bank accounts recorded no cash had been banked for a substantial period. HMRC had concerns that the ‘no sale’ and ‘void’ buttons on the till had been regularly used when in fact a transaction had taken place.
HMRC was also concerned about a number of negative sales, out-of-hours sales and under declared VAT due to a large number of sales being declared not subject to VAT.
HMRC concluded sales had been deliberately suppressed and raised VAT assessments for 2013, 2014, 2015 and 2016 totalling £5.1m. The assessments were not appealed by the company, which entered into creditors’ voluntary liquidation in December 2017.
In March 2018, HMRC confirmed, as additional sales income was not recorded in company accounts, additional sales plus VAT, less cost of sales, should be allocated to director’s loan account and therefore Mr Siza owed £4.1m.
With no funds in the estate, the liquidator assigned the claim to Manolete. Proceedings were issued claiming £4.1m in damages in breach of duty; in the alternative in debt. The Defendant did not respond to the claim and default judgment was entered on the DLA claim in the sum of £4.2m.
The Defendant applied to set aside judgment. Deputy Master Nurse refused the application, finding the Defendant had provided no evidence to support his explanation for the use of the ‘no sale’ and ‘void’ buttons. Further, the Defendant’s effort to blame his accountant for the VAT classification of items on the menu was “fanciful”.
The Defendant applied to Mr Justice Birss on paper seeking permission to appeal. The judge refused the application on the grounds that the explanations advanced by Mr Siza had not been put to HMRC at the time of the investigation and Mr Siza had not taken any steps to appeal the HMRC assessments.
The Defendant again applied at an oral hearing before Mr Justice Snowden for permission to appeal. Again, permission was refused. 
Many directors have engaged in tax avoidance schemes to the detriment of creditors and in breach of their fiduciary and other duties. Typically, on liquidation, the estate is left with no funds to pay for legal action, a situation brought about by the actions of the former directors against whom the claims lie. Manolete finance, whether by assignment or funding, ensures these claims are not stifled due to lack of cash.