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The High Court has ruled that two EBT schemes that involved making payments to employee-shareholders constituted an unlawful return of capital. This resulted in a breach of directors’ duties where the directors had not made adequate provision for the payment of creditors, including HMRC, and the company was or was likely to become insolvent. The decision highlights the court’s willingness to probe payments to members to ensure the proper formalities have been followed. Written by Paul Wright, barrister, 9 Stone Buildings.
Toone and others v Ross and another  EWHC 2855 (Ch)
‘If it looks like a duck, and quacks like a duck, we have at least to consider the possibility that we have a small aquatic bird of the family Anatidæ on our hands’ (Douglas Adams, Dirk Gently's Holistic Detective Agency).
It appears that this aphorism holds true for the court’s approach to the consideration of tax avoidance schemes. If a company enters into a scheme whereby its shareholders receive a tax-free sum of money from the company’s capital in proportion to their shareholdings, the court will examine whether it is in fact a distribution of the company's assets to its members.
This decision is a clear reminder to company directors and those advising them of the relevant considerations when distributing company assets. Tax is due on employment benefit trusts (EBT) contributions from the moment they are made and not only when the scheme is impugned by HMRC or the courts. Such tax must be properly accounted for and, at the very latest, once HMRC has opened an investigation, assets should not be distributed without first making proper provision for the tax due.
Between 2009 and 2013, the directors of Implement Consulting Limited (the company) caused its distributable reserves to be paid to the EBTs and an interest in possession fund (the IIP) (the schemes). Those reserves were then paid to its shareholders in proportion to their shareholdings. It was claimed that these payments constituted ultra vires distributions of capital.
In March 2013, one of the shareholders received a further £30,000 in expenses. The liquidators claimed the directors had breached their duties to the company by causing it to pay this money at a time when the company was insolvent without considering the interests of the creditors.
According to the company’s statutory accounts, it was in profit at all times between 2009 and 2012. However, in 2011, HMRC had given notice that it was investigating whether tax had arisen in relation to the EBTs. Similar notice was subsequently given in relation to the IIP. The total amount demanded by HMRC in respect of unpaid tax was £1.1m.
In RFC 2012 plc (in liquidation) (formerly Rangers Football Club Plc) v Advocate General for Scotland  UKSC 45 , the Supreme Court held that payments to EBTs constituted employees’ remuneration and were subject to tax.
The court is required to consider the reality of the transactions constituting the schemes rather than taking them at face value. Of particular importance to the judge were the facts that—(i) the payments were made from capital reserves—(ii) only those employees who were also shareholders received payments, and (iii) the shareholders received payments in proportion to their shareholdings. Properly considered through the eyes of the company, the payments to the schemes represented returns of capital to shareholders. As the required formalities were not observed, those distributions were ultra vires.
A company’s directors owe a duty to consider the interests of creditors when it is or is likely to become insolvent, according to section 172 of the Companies Act 2006. The tax liability was due (but not necessarily payable) from the time the company first transferred money to the first EBT. It did not only become due later upon the schemes being investigated by HMRC or being impugned by the court. Taking the HMRC debt into account, the company was insolvent in 2010.
The directors should have known of the insolvency by 2011. At that date, they had been warned by the scheme promotors that tax may be due, they had notice that HMRC was investigating the EBTs and there was evidence of a general decline in trading. Therefore, by paying one of the shareholders £30,000 for his expenses without making a proper provision for creditors, the directors had acted in breach of their duties.
Court: High Court, Chancery Division (Companies Court)
Judge: Chief Insolvency and Companies Court Judge Briggs
Date of judgment: 30 October 2019
Paul Wright is a barrister at 9 Stone Buildings. If you have any questions about membership of LexisPSL’s Case Analysis Expert Panels, please contact firstname.lastname@example.org.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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