Employee benefit trusts – If it seems too good to be true…

In this article, Simon Hough, a legal director and litigation specialist in our Business Support and Insolvency team, takes a look at employee benefit trusts and some recent decisions arising from claims against the directors who made use of them.

In 2017 the Supreme Court confirmed what many had anticipated by ruling that sheltering money in an off-shore trust to avoid paying tax and National Insurance constituted tax evasion and was unlawful.  The decision in RFC 2012 Plc (in liquidation) (formerly Rangers Football Club Plc) v Advocate General for Scotland [2017] UKSC 45 has had wide ranging implications for users of employee benefit trusts (“EBTs“) and has led to the liquidation of many of the companies involved and problems for directors who did not make any provision in their accounts for a potential charge to tax and could not then pay the hefty sums demanded when the Revenue came knocking.

Insolvency practitioners have relied upon the Rangers decision to bring claims against directors who sanctioned the use of tax avoidance schemes. Those claims have strengthened by the key decision of Ball (liquidator of PV Solar Solutions Ltd) and another v Hughes and another [2017] EWHC 3228 (Ch), which established that the use of an EBT was evidence that a director had acted in breach of duty, amongst other things. These developments in the law and media coverage of the issue led to the introduction of a retrospective charge to tax by the Revenue, called the loan charge, earlier this year which resulted in demands being made of companies who made use of EBTs.

Directors who have paid themselves tax free cash, sometimes running into millions of pounds, garner little sympathy from the Revenue when they cry foul and seek to defend the claims by explaining their reliance upon the scheme providers or professional advisers. The PAYE tax-paying public would also perhaps take a dim view of these antics. However, according to the not-for-profit Loan Charge Action Group, seven people have committed suicide in connection with the loan charge regime and, presumably, the pressure that it created in their lives. This is clearly a tragedy and the loan charge has become a political issue.

The newly elected prime minister has said that his government will review the loan charge. We have yet to hear from Mr Johnson on this but it is unlikely that these potentially significant recoveries for the Revenue will be abandoned altogether. The searchlight for claims and bad press may move towards the tax avoidance scheme providers (some of which are, unbelievably, still trading) and we may see an increase in professional negligence claims against them and their insurers, limitation permitting.

In the meantime, litigation against directors has continued but two recent decisions have created some confusion for office holders with conduct of employee benefit trust claims as one was successful and the other failed. Confusion creates doubt in the strength of claims (and the risk of the WIP) but when you look into the detail, the reasons for this discrepancy become clear.

In Toone and others v Ross and another [2019] All ER (D) 05 (Nov), the Court examined the use of EBTs by the directors of Implement Consulting Ltd. When they set up the scheme, the directors were advised by their accountant that, although the EBT had been endorsed by leading counsel, there was a small likelihood that HMRC would investigate as it was an aggressive tax avoidance scheme. Money was distributed via the EBT and HMRC subsequently notified the directors that is was making enquiries. This resulted in an assessment by the Revenue and a claim to unpaid tax. In this knowledge, the directors made further substantial payments via the scheme to a shareholder and employee, characterised as ‘expenses’.

Following the voluntary liquidation of Implement Consulting, the joint liquidators brought a claim against the directors alleging that they had acted in breach of duty by using the EBTs without making any provision for a potential charge to tax in the knowledge that there was a likelihood that HMRC would investigate. Further, the joint liquidators contended that the payments made after the Revenue sought unpaid tax and NIC were made whilst the company was insolvent.  The Court agreed and the claims against the directors were successful.

The same cannot be said for the joint liquidators in Re Vining Sparks UK Ltd (in liquidation) Allen and another (as joint liquidators of Vining Sparks UK Ltd) v Bernard and others [2019] All ER (D) 07 (Nov). This claim concerned an EBT that was set up in 2002, through which £3.3million had passed over an 11 year period. The trust arrangement was similar in structure to that used in the Rangers case. The joint liquidators issued proceedings against 4 directors but settled claims against 3, with their claim against the remaining director, Mr Bernard, disposed of at trial.

The claim against Mr Bernard was built upon an allegation of dishonesty. He defended the claim on the basis that he had followed professional advice and, in view of all of the evidence (and presumably in light of how Mr Bernard appeared in the witness box and his perceived integrity and reliability) the trial judge found that he had not been dishonest in the operation of the tax avoidance scheme.

Claims involving allegations of dishonesty in commercial proceedings are usually brought due to the effect of the passage of time and the availability of a limitation defence, which was surely the case here, as the EBT had been established a decade before the claim was brought. Whatever the reason for this pleading, the higher burden of proof for dishonesty was not discharged, the claim failed and Mr Bernard was not held liable.

When it comes to tax, if it seems too good to be true, it usually is and, since the imposition of the loan charge, those affected have been given an opportunity to get their affairs in order and settle with the Revenue (although ‘settlement’ will usually mean payment in full). If HMRC is the only creditor, insolvency practitioners risk finding themselves litigating only for their fees if a director is able to settle with HMRC direct. However, EBT claims will continue for the time being, particularly as there has been a softening in the Revenue’s position, in that they may not insist that a director should sell his or her home to pay the debt claimed. This is certainly not the case for a liquidator and is a motivating factor to bring a claim as this is often where the tax free cash has been stashed.

For expert advice on employee benefit trusts and insolvency matters, contact our experts.