Defending personal liability for tax avoidance schemes as a director

Claims against directors for unsuccessful tax avoidance schemes when their company enters into insolvency is not a new phenomenon, but a very recent case introduces a new potential defence for directors, as our Insolvency and Corporate Recovery specialist Tony Sampson explains.

Why would HMRC challenge a scheme?

The common scenario is that the directors have taken advice from their accountants and have entered into a variety of tax mitigation arrangements including, for instance, the now largely defunct avoidance device of “employment benefit trusts” (EBTs). More recently, there have been E Share arrangements and conditional share schemes.

Under the latter schemes, Company A subscribes at a massive premium for shares in Company B (Newco), and then the Newco itself issues shares to the directors of Company A. The shares then held by the directors of Company A are redeemed for substantial value. Company A thus avoids liability for PAYE and NI on the monies it has paid for the subscription of shares in Newco. It is not a taxable remuneration paid to the directors of Company A; rather, it is subscription monies for shares in another company (Newco).

The problem arises when HMRC decide to challenge the scheme and the company is put into liquidation as a result of assessments issued by HMRC. As a result, the director may face a litigious liquidator.

In some instances, companies which have already been liquidated and dissolved are restored to the register by HMRC and placed back into liquidation with an insolvency practitioner nominated by HMRC as liquidator. HMRC would file a substantial proof of debt in respect of unpaid PAYE and NI.

Liquidators, when dealing with the HMRC proof for outstanding PAYE and NI, would look to the company directors to discharge the HMRC liability on the basis that in entering the scheme, the directors had breached their fiduciary duties to their company.

It does not matter that the scheme was entered into a long time ago and the Limitation Act would normally have curtailed the chance of any recoveries – this is generally not regarded as a problem by the liquidator as arguably there is no limitation period in cases where the recipient directors personally benefited from the scheme.

Hunt v Balfour-Lunn & Others

The above scenario is similar to that in the recent case of Hunt v Balfour-Lunn & Others [2022] EWCH 984 (Ch) decided in April 2022.

In that case, HMRC’s claim in the company was substantial, involving many millions as the PAYE and NI tax liability had been incurred since 2002. The liquidator pursued the directors for breach of their fiduciary duties to the company, and also claimed that the directors had sought to put assets beyond the reach of creditors by entering into the scheme.

The directors defended the liquidator’s claim on the basis that they took and consistently followed their accountant’s advice. Those accountants had also taken a tax barrister’s advice (albeit in their own capacity).

The Court held that the directors were not in breach of their duties to the company. They had relied upon and followed their accountant’s advice. The judgment is expected to be appealed, but it is an interesting marker in the sand for directors’ liability in respect of robust company tax avoidance schemes.

Reliance on your accountant’s advice may potentially provide a defence for directors personally facing claims in relation to tax avoidance schemes following the insolvency of a company.

If you need any assistance in defending such claims, please contact Tony Sampson.