In the recent case against Lee Edward Lummis and Craig Stanley Lummis (the Directors) of Avacade Limited (the Company) brought by the Secretary of State for Business, Energy, and Industrial Strategy (the SoS), the court ordered disqualification of the Directors in relation to transactions entered before the Company was placed into liquidation and where the Company entered into various tax planning schemes. The decision provides helpful guidance in relation to directors' duties in the context of employee benefits schemes – even where (as in this case) the tax liabilities have still not crystalised.
The Secretary of State for Business, Energy & Industrial Strategy v Lee Edward Lummis and Craig Stanley Lummis  EWHC 1501 (Ch)
The Company was formed in January 2010 with the Directors being appointed at the outset. The Company carried on business as an investment broker.
In 2012 the Company implemented various tax planning schemes on the advice of EDF tax and Qubic tax (EDF Scheme and Qubic Scheme respectively; together the Schemes) pursuant to which it transferred significant amounts to trustees of the schemes. These amounts were intended for the ultimate benefit of employees but it was anticipated the Company would be entitled to deduct corporation tax prior to any payment to the employees.
HMRC first enquired about the EDF Scheme in 2014 and the Company was admitted to a Representative Sample Arrangement (RSA).
On 15 July 2014 the Directors passed a resolution to sell its customer database for £150,267 (completed shortly afterwards), and to cease trading and wind-up the Company following receipt of pipeline income.
At the time, the Directors asserted that the Company owed them circa £1.8 million each in connection with unpaid remuneration, bonuses and monies applied under the Schemes. The consideration for the customer database was therefore never received by the Company and instead it was debited to the Directors' loan accounts. Subsequent payments totalling c.£1,6m received by the Company in connection with the historic business were credited to the Directors and trading creditors, who were paid in full.
In September 2015, the Directors contacted a firm of insolvency practitioners, for advice. The Directors advised that they were the only creditors of the Company but this position was contradicted by an amended corporation tax assessment to the amount of c.£1.2m received by the Company's accountants.
The Company entered into liquidation on 6 November 2015 and on the same day HMRC issued PAYE determinations in the total sum of c.£10.2m under Regulation 80 of the Income tax (PAYE) Regulations 2003 and Notices under Section 8 of the Social Security Contributions (Transfer of Functions etc) Act 1999. These notices were challenged by the Company.
It is worth noting that there has still not yet been judicial determination of the effectiveness of the EDF Scheme.
In October 2018, the SoS issued proceedings against the Directors under section 6 of the Company Directors Disqualification Act 1986.
The SoS's position
The SoS sought disqualification orders against the Directors based on the grounds of unfitness. In broad terms, the SoS claimed that the Directors caused the Company to enter into transactions for their own benefit totalling over £1 million between 1 August 2014 and the date of liquidation, while being aware that the Company was subject to a contingent liability to HMRC: it was part of RSA in respect of the EDF Scheme and, dependent on the outcome of the investigation, could have resulted in a liability to HMRC.
The matters came before His Honour Judge Halliwell sitting in the High Court who handed down judgment on 4 June 2021.
The Judge noted that the material question was whether the Directors entered into the transaction aware of a risk that the EDF Scheme would be held to be ineffective and could attract a tax liability. The Judge was satisfied that, on the facts, this was the case.
The Judge went on to consider the correspondence from the EDF Scheme tax promoters, which stated that it was possible that the EDF scheme would be challenged by HMRC. It also included a warning that, despite the view of tax counsel that the EDF Scheme was effective, they could not guarantee that it was.
Further, the Judge observed that the Company's financial statements for years 2013 and 2014 contained a note to the effect that the Company will liable for any PAYE/NIC that might arise if the Schemes prove ineffective.
The Judge determined that the Company was balance sheet insolvent on 1 August 2014 at the latest. From this date the Company had no assets other than expected receipts in relation to the historic business, as the Company had ceased trading.
The Judge then noted that directors of an insolvent company are under a duty to have proper regard for the interest of the company's creditors as a whole, to act in good faith, to avoid conflict of interest and to exercise reasonable skill and care. The Judge confirmed that the directors owe the same duties to contingent creditors, such as HMRC as on the facts of this case.
The Judge also noted that the Directors made no provision out of the Company's assets in respect of a contingent tax liability nor there was evidence that they had considered the Company's position in the event that such liability arose.
The Judge was satisfied that the Directors caused the Company to sell the database and enter into subsequent transactions without proper regard for the interest of the creditors as a whole and they were in breach of their duties. The Judge subsequently made disqualification orders against both Directors, with the length of disqualification to be decided at a later substantive hearing.
The decision in this case demonstrates that directors of companies which enter into tax planning schemes are on notice that such schemes might not be effective and must make provisions for tax liabilities. Directors will also not be able to hide behind ongoing judicial review proceedings in respect of any such tax scheme.
The court’s approach in this case complements that of several of the cases pursued against directors by liquidators in connection with tax avoidance – not least Re Implement Consulting Limited (in liquidation) which was a landmark judgment in which our team was successful, one of several claims we have underway relating to disguised remuneration schemes.