HMRC unable to pin SME’s tax and NIC debt on its director
HMRC are increasingly looking to legislation contained in Reg. 72 Income Tax (PAYE) Regulations 2003 and Reg. 86 Social Security (Contributions) Regulations 2001 that enables PAYE tax and NIC debts to be transferred to the employee in specific circumstances.
For tax the rules are narrowly defined:
1. The employer did not deduct PAYE;
2. The failure was wilful and deliberate; and
3. The employee received the remuneration knowing that the employer had wilfully failed to deduct the tax.
All three of these circumstances must be present before the PAYE tax debt can be transferred.
For employee’s NIC HMRC must be able to demonstrate that the failure to pay the NIC is either due to an act or default of the employee and not the employer’s negligence OR that the employee knows that their employer has wilfully failed to pay over the NIC and not recovered it from the employee.
The letter of the law that has been an ally to HMRC on so many occasions worked against them in a recent First Tier Tax Tribunal case that involved the application of this debt transfer legislation.
Background
From 2003, Stephen West was the sole director and shareholder of Astral Telecom Ltd (Astral), whose trade consisted of selling satellite space to the telecoms industry.
Mr West regularly drew monies from his company which were treated as director’s loans. At the end of each year he would vote himself a small amount of salary and a larger dividend which would be used to repay the outstanding loans. However, for a four year period ending 30th April 2010, director’s loans mounted up and remained outstanding.
Towards the middle of 2011, Mr West became concerned about the state of his company’s business and knew that he could be liable for Astral’s debts if it traded while insolvent. In June 2011, therefore, he met with an insolvency practitioner who advised him to put Astral into liquidation. West was also told that the company could not pay him in dividends for that year as there were insufficient profits and any payment to him would have to be wholly by way of salary.
West instructed his accountant to prepare final accounts showing an amount of net salary sufficient to clear the outstanding director’s loan account. This came to £129,150, the gross being £202,967.
Together with employer’s NIC, the total PAYE and NIC debt as per the draft final accounts to 26th July 2011, was just shy of £100,000. This was in addition to VAT and Corporation Tax owing of nearly £40,000.
HMRC enquiry
In February 2013, HMRC began enquiries with a view to establishing why Astral had not paid its PAYE liability over to the Revenue. In response, Mr West stated that he was prepared to consider voluntarily paying the sums due to HMRC. In this spirit of co-operation, HMRC said that they would recalculate the PAYE liability on the net figure of £129,150, thereby considerably reducing the amount payable and invited West to settle on this basis. Mr West however failed to respond, so in October 2013 HMRC issued separate income tax and NIC assessments transferring the PAYE liabilities of just over £46,000, for the tax years 2010/11 and 2011/12 to West on the basis that he received payments from Astral knowing that it had wilfully failed to deduct sufficient tax.
This prompted West to make a ‘without prejudice’ offer of £25,000 in full and final settlement, but this was rejected as it was insufficient.
Following exchanges of correspondence, West lodged a late appeal against the assessments in March 2014 and requested a review of HMRC’s decision. The review however simply upheld the original decision and so the matter progressed to the Tribunal.
Tribunal hearing
Arguments for HMRC
HMRC contended that the retrospective exercise of grossing up director’s remuneration to eliminate Mr West’s indebtedness to Astral did not constitute the proper operation of PAYE and that this was no more than a “paper exercise” authorised by West with the aim of clearing his overdrawn loan account and with a view to preventing the liquidators from recovering the debt from him personally.
Split decision
The two members of the Tribunal panel differed in their views, so it was left to the Judge to use his casting vote to decide the issue.
Judge Clark was satisfied that tax was properly deducted and, as such, the first precondition of Reg. 72 was not fulfilled and there was no basis to transfer the PAYE tax debt to Mr West.
Turning to the question as to whether West knew that Astral wilfully failed to pay employee’s NIC, it
was clear that Astral had not paid the contributions to HMRC, but was this a wilful act? In the Grounds for Appeal, Mr West’s representative submitted the following:
“Clearly the company did not pay the NIC, and Mr West knew this. However, the failure to pay the NIC was not wilful, or deliberate, because by the time it became due for payment, the company had no means to pay the liability, and therefore could not pay it.”
The Judge was satisfied that Astral’s position, at the time the final accounts were drafted and the salary allocated to clear the director’s loan account, was such that it would not have been open to it paying the resulting NIC to HMRC. The failure to pay the NIC was not therefore wilful or deliberate.
Ms Sandi O’Neill, the other panel member, stated that West knew that the PAYE and NIC deductions were book-keeping entries which were merely a cosmetic calculation and that in reality no such deductions had taken place because Astral had no means of paying the sums due to HMRC.
Ms O’Neill warned that Judge Clark’s decision to find in favour of Mr West would leave the door open for owners of failing small businesses to go into liquidation and make preferential and potentially unjust payments to themselves ahead of other creditors, like HMRC, who are then unable to recover their debts from a liquidation of the companies’ assets.
Negligence pays.