Complacency in the business world can be a dangerous thing. We may think our offering is the greatest thing since sliced bread, particularly if we are lucky enough to have third parties and trade journals telling us so. We may even be confident that, with new work flowing in quite freely, our businesses’ profitability and liquidity are as good as they ever have been. However, the stark reality we must not lose sight of at these times is that our ability to hold onto market share, and sometimes our business itself, is rarely stronger than our last major contract and that our economic futures can be much more fragile than we think.

Despite an uptick in the general economy (or perhaps in part because of it, with the ever-present risk of overtrading to meet demand and the government seemingly having to find a pretty penny to pay our performance related dues to Brussels) at least one risk appears recently to be increasing. For VAT registered limited companies in particular, the shadowy figure of the VATman has now been sighted, waiting in the wings, showing debtors less and less patience day by day.

The Parkwell case

The directors of Parkwell Investments Ltd will have learned this lesson the hard way when their company was wound up this October in the High Court upon a petition issued by HM Revenue & Customs for unpaid VAT; this despite the fact that they were at the time already contesting HMRC’s claim through an appeal to the First Tier Tribunal (Tax) (FTT). The directors would have had some cause for optimism when they challenged HMRC’s petition (and attendant provisional liquidator appointment) on the grounds that the Court did not have jurisdiction to wind them up in view of the pending appeal; in another High Court case earlier this year (Enta Technologies Ltd) another Judge had suggested it was wrong for a court exercising winding up jurisdiction to usurp the function of the FTT, and that they should instead await the outcome of an appeal before making a winding up order. In Parkwell, however, Sir William Blackburne declined to follow this reasoning, holding instead that:

“The true question, to my mind, is whether the appeal to the FTT, assuming one is launched, has any merit. If it has none the assessment, which so long as it remains stands as a debt due from the person assessed (see section 73(9) of the Value Added Tax, 1994), continues to constitute both a basis upon which HMRC may petition for the company’s winding up and evidence of the company’s insolvency. If the court, on a review of the evidence before it, considers that the company has a good arguable appeal which will lead either to the cancellation of the assessment or to its reduction to below the winding-up debt threshold, it will dismiss the petition.”

Implications for companies

Whilst every case ultimately hangs on its facts, and in Parkwell it was found that the FTT appeal was effectively groundless, this decision means we have to assume the High Court – very often in the context of a relatively short, urgent hearing – will be prepared to carry out a summary appraisal of the merits of a VAT assessment even if HMRC know there is a more detailed appeal pending before the FTT at the time they issue their winding up petition. Given that we were already seeing a hardening of HMRC’s position towards debtors generally before the Enta decision, it must follow from the removal of this ‘obstacle’ that if HMRC themselves think they have a strong claim, they will increasingly press ahead with a winding up petition.

As anyone whose company has ever faced a winding up petition will know, its harmful effects are often felt immediately, many weeks before it ever comes before a Court. Ever more sophisticated trading partners find out about it through their information channels and block credit, bank accounts are typically frozen, you cannot pay out cash or other assets belonging to the company, even wages, without applying to Court for an expensive validation order.

Even if a company’s tax advice is that there should (following an appeal against assessment) be no substantial VAT liability to pay, it nevertheless seems the amount HMRC has issued an assessment for may well have to be found by the company in any event, in order to avoid drastic consequences. If this money cannot be found and set aside for this purpose, a winding up petition is likely to follow and immediate insolvency advice should therefore be sought. The implications of this on cash flow will be most keenly felt by companies which lead a more ‘hand to mouth’ existence and are unable easily to provision for a significant buffer in terms of tax which may be demanded.

Implications for directors

Time and again in my practice I see that an HMRC petition has actually precipitated the failure of a company even if the underlying business was sound. Hopefully it will still be possible to salvage the core business value even after a petition has been issued by taking immediate advice from an insolvency practitioner if this happens, but the options at that stage will be severely limited and if liquidation does eventually ensue the directors individually will come under a bright spotlight. This may be with a view to liquidator claims on behalf of creditors for wrongful trading, etc, and/or directors’ disqualification for (for example) trading at the expense of the Crown (in effect for having had too little regard to HMRC’s position as an involuntary creditor).

In my experience, a director will not easily be able to explain away why a liquidated company was left with a large shortfall to the Crown, whilst perhaps his directors loan account and/or the overdraft he had personally guaranteed were kept in check / paid down, by reference to the company’s accounting advice alone. By the time possible claims and/or disqualification action hit the director’s doormat, s/he will very likely have last seen the company’s books and records 18 months or more ago, when they were handed to the liquidator, and s/he may well in truth never have fully understood how much should have been put aside for tax or have any idea how to put together a defence. To guard against this clear and present risk, I suggest that all directors would benefit from:

  1. having clearly defined roles and responsibilities within their companies (no matter how small) agreed between themselves and recorded in writing;
  2. ensuring (even if they are not primarily responsible for finance within the company) that they have a reasonable handle on the forward-looking cashflow requirements of the business;
  3. ensuring they know (ideally by reference to contract terms) exactly what the company’s accountants and other professionals are engaged to do, particularly in terms of management reporting;
  4. insisting that the commercial basis for any key management decisions is recorded in a contemporaneous board minute; and
  5. keeping securely for at least 5 years their own personal records of key documents such as directors loan account payments and receipts, management accounts and board minutes received.

Conclusion

Given the seeming willingness today on the part of HMRC to pursue debtor companies aggressively, and to sponsor both provisional liquidators and liquidators to take urgent recovery action, actual and prospective tax liabilities must now be afforded due priority by management.

If a VAT (or other) assessment is received which the company cannot afford to pay, in addition to taking immediate accounting and/or legal advice with a view to a possible appeal, the board should be making a second call, to a qualified insolvency practitioner (your accountant or solicitor will be pleased to make a recommendation / introduction) at as early a stage as possible to assess the available options.

Provided professional advice received is followed, this will have the dual effect of allowing the board to explore the widest range of available options to (hopefully) avoid an insolvent procedure whilst simultaneously providing the maximum level of protection for individual directors against future claims and/or disqualification in the event an insolvent procedure cannot be avoided.

Far better, of course, is to ensure that the company is always on top of its tax exposure and to manage it proactively in close cooperation with accountants so that no assessment arrives which cannot be paid!

If you have an issue with a VAT or other tax liability, a winding up petition, liquidation or post-liquidation claims, or any other actual or prospective insolvency-related question, please do not hesitate to contact me.