The after-effects of the Rangers decision are being felt beyond the tax tribunals. In two recent decisions (Re Vining Sparks and Toone), the High Court has considered the role and responsibilities of directors approving the entry into similar EBT schemes. The decisions reached differ, but what is clear is that directors must consider the entry into and impact of enquiries made into tax avoidance arrangements carefully, question and fully understand related risks and would be well advised to obtain independent advice beyond that of the promoter of the scheme itself. Second opinions should be capable of reliance: ‘phone a friend is’ not enough.
It always pays for those in the tax world to look up from the decisions of the tax tribunals and higher courts and see what is happening elsewhere in the courts. Two judges in the Bankruptcy and Companies Court heard separate cases in early October. In both those cases, liquidators brought claims against directors for HMRC debt for unpaid PAYE and NICs liabilities related to EBT avoidance schemes.
The tax avoidance arrangements were closely aligned to the planning in RFC 2012 Plc v HMRC (the Rangers case). The Rangers planning was held to have failed by the Court of Session ( CSIH 77) and the Supreme Court ( UKSC 45). There was no dispute that the schemes in these cases under consideration failed on the same basis.
The basic Rangers planning involved establishing an EBT into which payments were made by the company. Under the terms of the scheme, however, the employee had no interest in or contractual right to the EBT funds. On that basis, it was argued that the payments did not represent earnings or emoluments of employment and no PAYE or NICs was deducted. A recommendation was then made by the company to the trustees that the funds should be re-settled into a sub-fund with the capital and income of the sub-fund applied in accordance with that employee’s wishes. The employee, as protector of the sub-fund, could direct who the sub-trust beneficiaries should be (typically family members). In the interim, the employee could request a loan in an amount up to the sub-trust funds. That loan was renewable and not expected to be repaid until the employee’s death (at which time it would be deductible when calculating the estate value for IHT purposes).
The first decision: Re Vining Sparks
The tax avoidance scheme entered into by the company in Re Vining Sparks UK Ltd (in liquidation)  EWHC 2885 followed the Rangers planning almost exactly, and Baxendale Walker was the promoter of the arrangements in both cases. The company had subsequently gone into liquidation. The liquidators brought a claim against the directors for just over £1.5m: this was the amount of the debt for which HMRC proved in liquidation.
Claims by the liquidators
There was no argument that the Rangers decision applied to the EBT scheme and that therefore payments made to the EBT were subject to PAYE and NICs. The question at issue was the role of the directors and, specifically, the role of one of the directors in particular. The liquidators argued that in choosing to adopt the scheme, the director had acted in breach of his director’s duties and had also entered into fraudulent activity. A further claim was brought specifically in respect of the amounts paid to the sub-trust operated for the benefit of his family.
The claim brought for breach of director’s duties was for breach of the duty to promote the success of the company. Section 172 of the Companies Act 2006 sets out the basic good faith duty and the considerations that must be taken into account when exercising it.
The key arguments made by the liquidators against the director were that:
- He caused the company to adopt a scheme which concealed the true nature of what was going on (i.e. payment of emoluments to employees). In particular, information provided to HMRC was misleading because it failed to disclose/concealed on the company’s intentions.
- He could not have had a reasonable belief that the scheme worked to avoid PAYE and NICs liabilities. He knew that the scheme did not reflect his actual knowledge in respect of the money received by him and other employees.
- He should have obtained independent advice. It was insufficient to rely on the advice of the promoter. In addition, some of the subsequent advice received from the promoter, including advice to ‘shuffle’ papers provided to HMRC, should have put the directors on warning.
- No reasonable director, acting in good faith, could have reached the decision to enter into the EBT scheme and make payments to the EBT without deduction for PAYE or NICs.
The director’s defence was that he had acted in good faith. He had understood the proposals to be a legitimate tax avoidance scheme which would enable employees to receive new contracts and high rewards at no additional cost to the company and that this would aid recruitment and retention in a highly competitive field. This understanding was based on the advice received from Baxendale Walker (the scheme promoters), advice from accountants to the company’s US parent company and informal advice received by the company’s in-house counsel who had ‘sounded out’ six city firms and received ‘favourable reports’.
Reliance on the promoter’s advice
Judge Jones was highly critical of the reliance on the Baxendale Walker advice. He refers to Mr Baxendale Walker advising on his own schemes as a clear conflict of interest. Baxendale Walker stood to benefit from commission if the scheme was adopted. Promoters could not provide independent advice on their own schemes: ‘Even towering, unbreachable [Chinese] walls would be insufficient’ to address that conflict. In Judge Jones’ view, this should have been clear to both the director and inhouse counsel. The advice obtained from the accountants to the US parent company was only given in general terms before the specifics of the scheme were known. It provided the directors with some backdrop against which to assess the decision to enter into the scheme but could not be seen as providing any challenge to or superseding the promoter’s advice or curing its lack of independence.
The duty to act in good faith
Acting in good faith requires honesty, integrity and fairness. The question of honesty has received a fair amount of commentary following the decision in Ivey v Genting Casinos (UK) Ltd  UKSC 67. Judge Jones considered the two-stage test. The first, subjective, test looks at the director’s state of mind or belief on the basis of facts that were known (or ought to have been known if he didn’t turn a blind eye) by the director at the time. The second test then requires an objective assessment of whether or not the director’s conduct was honest.
The court held that dishonesty had not been established. The advice obtained and subsequent reassurance obtained from Baxendale Walker all supported the director’s understanding that the scheme successfully avoided liability for PAYE and NICs as it did not give rise to payments of earnings or emoluments. The scheme was sold to the director on that express basis and he received no contrary advice. Even when potential liability was questioned by the EBT trustee, Baxendale Walker’s advice in response was very clear and positive. The court was critical of the failure of the directors to obtain independent advice but that criticism went to whether they had exercised the appropriate duty of care and not, specifically, to whether they had relied on the advice obtained honestly.
The decision makes interesting comments as to what would constitute dishonesty in this context: it comes down to whether there was dishonest intent in establishing the scheme arrangements. There was no concealment within the trust deed and documentation of the scheme’s artificiality. The use of letters of wishes recommending action to the trustees was not evidence that they acted in breach of their trustee duties. Both these factors were evidence of the operation of an avoidance scheme, not evidence of dishonesty. The same basic principles applied to the granting of the loans. The key question for the director was whether he believed that the scheme worked. He did and his reliance on the advice received was not dishonest. Baxendale Walker provided advice robustly countering concerns and, at the relevant time, Baxendale Walker’s advice was supported by decisions in Dextra  EWH 872, Sempra  STC 1062 and the early Rangers decisions.
To the director’s mind, the scheme enabled the employees to receive higher rewards at no cost to the company, thereby promoting the success of the company by aiding recruitment and retention.
The director was found to have acted in good faith and the absence of dishonesty meant that there were no grounds for the alternative claim of fraudulent trading and the application notice was dismissed. In its conclusions, the court reiterated that independent advice should be obtained by the board when considering these kinds of arrangements but was also clear that a failure to obtain independent advice does not automatically determine the subjective good faith test.
The second decision: Toone
The result for different directors of a company which had also entered into an EBT avoidance scheme was significantly harsher.
This second case – Toone and another v W Ross and another  EWHC 2855 (Toone) – was argued quite differently, but it covers much of the same ground. The company had again looked at how it could structure payments to its key employees in a tax efficient manner and had entered into an avoidance scheme. The scheme again involved EBTs with a sub-fund for the benefit of a particular employee’s family which made loans to the employees. The scheme’s promoters had designed the scheme and had set up a large number of similar arrangements. Information provided by the promoters included a document setting out key points of the arrangement, tax benefits and the functioning of the EBT. It also included a letter setting out the promoter’s view of the risk of the scheme failing. This made reference to favourable tax counsel opinions and the fact that none of their arrangements had been challenged but also noted that such challenge might take many years. One key difference was that the employees who benefited from the EBT arrangements were also the company’s three shareholders: the arrangement was not in place for other employees. A second scheme, from the same promoters, which was designed to avoid higher rate and additional rate tax on distributions to shareholders by use of planning involving an interest in possession trust, was entered into in 2012.
The advice taken beyond the promoter’s information documents and presentations was limited. One director of the company had called a lawyer friend and had drawn some comfort from his view that EBT schemes ‘worked’ but the court were clear that the conversation did not amount to even informal advice as the friend had no details of the actual scheme proposed. The only advice obtained that was recognised by the court was that taken from the company’s accountant who had discussions with other accountants at seminars and took some steps to understand how the planning worked. Neither he nor the directors saw legal opinions mentioned in the promotional materials or sought formal independent advice.
HMRC wrote to the company in June 2011 advising that they were enquiring into the company’s use of a marketed avoidance product and that they intended to raise formal assessments with regard to PAYE and NICs. Shortly afterwards, HMRC wrote to the company’s accountants suggesting settlement terms. Determinations were then sent by HMRC in March 2013 by which time the company had ceased trading. The accounts for the year ending 2012 did not make a provision for amounts assessed by HMRC.
The key arguments raised by the liquidators were that:
- payments made to the EBT were unlawful distributions made contrary to Part 23 of the Insolvency Act 1986; and
- the directors had breached their statutory duties by allowing the payments.
More specifically, the liquidator argued that the directors had always know that the avoidance scheme did not work, had paid away funds to the EBT and interest in possession trust rather than making proper provision for HMRC and that, had the PAYE and NICs liabilities been properly taken into account, the company would have been insolvent at the time the later payments were made. This was strongly disputed by the directors who argued that until the 2015 decision of the Court of Session in Rangers, case law supported the efficacy of the scheme.
Unlawful distributions and breach of director’s duties
The court held that the payments to the EBT and the interest in possession trust were, viewed realistically, distributions, with the trusts acting merely as conduit vehicles for those distributions. This was supported by the fact that the payments were made in proportion to the directors’ shareholdings. The distributions made after receipt of HMRC’s letter were unlawful as, taking into account its potential liabilities to HMRC, the company was insolvent at that time.
This first part of the decision turns heavily on the fact that the key employees, directors and shareholders were the same people. The court went on to consider the wider question of directors’ duties. Judge Briggs held that HMRC’s June 2011 letter put the directors on notice of a substantial debt owed to HMRC. Entering into arrangements to distribute assets from this point, without making proper provision for creditors, was a breach of duties owed by the directors to the company.
As was the case in the first decision, the directors are heavily criticised for their failure to take any formal independent legal advice. However, Judge Briggs goes further in reaching what he acknowledges will appear a ‘harsh conclusion’ to the directors. Despite their honesty, when entering into the schemes, the directors, in his view, ‘chose to take a risk which they did not fully understand’. This was compounded by the failure to take independent legal advice, to read opinions from leading counsel provided to the scheme promoter or to seek comfort from HMRC in respect of the schemes. The failure to take these steps was not reasonable conduct. Judge Briggs concludes that this lack of understanding hindered them from making decisions in accordance with their statutory duties.
There are two particularly notable messages from these decisions. The first is the importance of formal independent advice when considering marketed tax planning arrangements. The second is the need for directors to make sure that they fully understand the risks inherent in planning. If they fail to do so, they face a risk of personal challenge and the strict liability consequences of a failure to act in accordance with their statutory duties. In Toone, the failure to provide for the contingent HMRC debt and subsequent entering into of an arrangement to achieve a distribution of assets was a breach of director duties despite the fact that HMRC’s letter asserting the liabilities pre-dated HMRC’s successful Rangers appeal at the Court of Session. This is a striking conclusion which raises questions as to how directors should react to HMRC enquiries whilst still at a relatively early stage. Directors and tax advisers need to be equally alive to these decisions.
The authors thank Susie Brain, senior knowledge lawyer at Norton Rose Fulbright, for her contribution to this article.
This article first appeared in Tax Journal.
Global: COVID-19 and the approach to proceedings, hearings
Inevitably and like every sphere of normal life, existing dispute resolution proceedings, whether in national courts or arbitration, are already experiencing the impact of the COVID-19 outbreak. Where possible, hearings have been delayed or relocated. However, as the lockdowns extend for the foreseeable future, hearings will still need to be held. Many national courts and arbitral institutions are now alive to these issues and are looking at solutions, in particular technological ones.