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The phoenix must die

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by Contractor Weekly

HMRC discussion document on tax abuse and insolvency

The practice of ‘phoenixing’ or ‘phoenixism’ involves carrying on the same business or trade successively through a series of limited liability entities (usually companies) where each becomes insolvent in turn. Each time this happens, the insolvent entity’s business, but not its debts, is transferred to a new ‘phoenix’ entity.

From HMRC’s perspective, phoenixism involves the running up of tax liabilities in a company, then avoiding making payment by making the company insolvent. A new company is then set up by the same person who owned the insolvent company, which will then acquire the assets of the old company, sometimes at less than their full value, so as to increase the benefit to the person(s) driving these actions. This creates unfair commercial advantages.

Phoenixism is unfair to all those creditors who go unpaid even if the insolvent company’s business continues, but bites harder for HMRC. In many instances, creditors other than HMRC will be paid by the new company in order to secure ongoing supplies and ensure that the business can continue in the new company.

Workers can also be affected when their employer goes into liquidation. If PAYE and NIC have been deducted from their earnings but not paid over to HMRC by the company, this could affect their personal record of NIC contributions impacting on certain entitlements.

Whilst HMRC has some powers to address attempts to abuse the insolvency rules to avoid paying tax, they are not uniformed. For example, if an insolvent company is found to have deliberately underpaid Corporation Tax and Excise duties, HMRC can transfer liability of the Excise duty penalties to the insolvent company’s directors, but not the Corporation Tax.

Example of phoenixism

Phoenix Ltd is a close company that has recently been formed. Over a period of 12 months, Phoenix Ltd accumulates large debts, including tax debts, stalls creditors for as long as possible, and eventually goes into liquidation. Shortly afterwards, Phoenix Co. Ltd purchases the productive assets and takes over the operations of Phoenix Ltd. Phoenix Co. Ltd operates out of the same premises as Phoenix Ltd, with the same suppliers, employees, and customers.

Avoidance, evasion and insolvency

Some people who are involved in tax avoidance, tax evasion, or repeated non-payment, seek to misuse insolvency in an attempt to swerve their tax liabilities at the point they are rumbled by HMRC. They might do this in a number of ways, for instance:

  • the controlling director/shareholder uses tax avoidance or tax evasion to extract value from a company;
  • the company accumulates tax debts but pays its suppliers to ensure their support so that the director/shareholder can continue the company’s business through a successor company if necessary;


  • the company becomes insolvent, stripped of its assets with which to meet all its debts, often because those assets have disappeared in anticipation of the winding up;
  • the controlling director/shareholder may continue acting in another guise, e.g. same trade, using the same customers/suppliers etc.

Example – tax avoidance

The director of Legit Ltd, Mr Underhand, uses a tax avoidance scheme to extract money from the business without paying tax and to increase business profits available for extraction. The avoidance scheme was used in the years 2008-2010 and HMRC begin a compliance intervention into the company’s returns. In 2011 the business of the company is sold to a third party at full value and the profits from the sale are extracted for the benefit of Mr Underhand via another tax avoidance scheme. No funds are left in the company to pay the potential tax liabilities if the avoidance schemes fail. In 2012 HMRC raises assessments for the understated tax. The company appeals against the assessments and payment of the tax is postponed pending the outcome of the appeal. HMRC wins on appeal. The company is unable to pay the tax due and Mr Underhand places Legit Ltd into voluntary liquidation in January 2015.

Mr Underhand delivers up minimal books and records to the liquidator so that he only becomes aware of the avoidance debt when informed by HMRC. The liquidator sets about pursuing the recovery actions.

Mr Underhand offers £500,000 to settle the claims against him of £1.2million. The liquidator accepts the settlement and, as a non-preferential creditor, after costs HMRC receive £200,000 in relation to a tax debt of £1million.

Example – tax evasion

Shady Ltd ran a business with very few employees on the payroll. On investigation, HMRC found that the company had been deliberately hiding the employment status of their workers from HMRC by falsifying their company records, and that a lot of self-employed workers providing services to Shady Ltd should actually have been treated as employees. Over £6M of PAYE and NIC had been evaded as a result of this. Following HMRC’s investigation, Shady Ltd agreed to put all its workers onto RTI, and returns were submitted to HMRC. However, no payments were made to HMRC, and in the meantime Shady Ltd’s director purchased another company – Dodgy Ltd – and put Shady Ltd into administration. All of Shady Ltd’s employees were transferred across to Dodgy Ltd. The director of Shady Ltd was made to resign from Dodgy Ltd in order to allow Dodgy Ltd to continue as a business and meet other regulatory requirements – however he continues to run the business behind the scenes. Since then, Dodgy Ltd has paid all of its PAYE, NICs and VAT liabilities, totalling £5M. However, the tax of £6M relating to Shady Ltd remains unpaid.

One of the challenges to HMRC in tackling this behaviour is how debts are established under the tax framework. Most creditors establish that a debt is owed to them when they invoice the company for the provision of goods or services. By contrast, there is usually a time difference between when the tax liability arises and when a debt is established by HMRC. This means that there is sufficient scope for a company to enter into insolvency after the tax liability has arisen but before the debt is enforceable.

HMRC does have the power to require high-risk businesses to provide an upfront security deposit, where it believes that there is a serious risk to the revenue. Security intervention is only considered in a small number of cases where there is clear evidence that a significant amount of revenue, relative to the size of the business, is at risk. In addition, there must either have been failure to comply with return filing and payment obligations, or the personnel actively involved in a current business must have been actively involved in another business that failed to pay the taxes that were due.

A separate consultation on extending the security deposit legislation to Corporation Tax and Construction Industry Scheme deductions was launched last month, and whilst complementary, this would not provide a full solution to the problem.

Insolvency practitioners

Insolvency practitioners are qualified persons who are licensed and authorised to act as office holders in relation to insolvency proceedings. They have a number of legal actions available to them to clawback assets from the director/shareholder and/or to impose personal liability on them for the company’s debts pursuant to the Insolvency Act 1986. However, pursuit of these proceedings is:

  • expensive;
  • reliant on the provision of information to the insolvency practitioner and/or HMRC;
  • subject to litigation risk; and
  • dependent on the insolvency practitioner’s appetite for such litigation.

As a result, even if proceedings are instigated they often end up in a “commercial” or discounted settlement being reached.

All of the above means that a controlling director/shareholder who chooses to misuse insolvency may receive a significant discount on the tax liability or pay nothing at all – enabling them to retain the fruits of tax avoidance, tax evasion and/or the commercial advantage of repeated non-payment.

In a bid to tackle the small minority of taxpayers who abuse the insolvency regime in trying to avoid or evade their tax liabilities in these ways, HMRC have recently published ‘Tax Abuse and Insolvency: A Discussion Document’.

Possible solutions

Transfer of liability

Whilst HMRC can already transfer liability of certain tax debts to company officers in particular circumstances, this power could be extended to transfer liability of tax debts to the person responsible for the avoidance, evasion or repeated non-payment of taxes when there is a risk the monies will be lost in insolvency.

Joint and several liability

This principle would enable HMRC to hold the persons responsible for the avoidance, evasion or repeated non-payment of taxes jointly and severally liable for tax debts in the event that the company could not meet the tax debts.

Compliant companies who fall on hard times however could be at risk under this proposal if they went through a period of not being able to pay HMRC PAYE, VAT, Corporation Tax etc on time.

Safeguards would therefore have to be put in place to ensure that these taxpayers would not be targeted by such measures.

The closure date for all comments is 20th June 2018.