Employee Benefit Trusts (“EBTs”) have become prevalent in recent years. They were originally devised as a form of discretionary trust to benefit employees and in most cases continue to be operated as a legitimate part of employee incentive plans, such as to house shares for distribution to employees.
EBTs – The Bad
However, a second tier of “bad” EBT structures has evolved over time which have become increasingly more elaborate in nature as HMRC have increased their efforts to clamp down on their abuse. In some cases, these schemes have been shown to have no purpose at all other than to avoid the payment of Pay As You Earn tax (“PAYE”) and National Insurance (“NI”) contributions on income to key employees, and in some cases to benefit from Corporation Tax (“CT”) relief. This is clearly an issue for HMRC, but it is increasingly becoming an issue for insolvency practitioners too, not least due to the fact that HMRC as a major creditor in most of these cases will insist that action be taken against the directors by the office holder. See our blog, Employee Benefit Trusts and insolvency – the next big thing?
If a company enters insolvency having made distributions through an EBT to a key employee whilst creating an unpaid tax liability and not paying other creditors, the insolvency office holder will have to consider carefully whether the director(s) could be liable to a claim for misfeasance or whether the transaction can be challenged as a transaction defrauding creditors under sections 212 and 423 respectively of The Insolvency Act 1986.
The tide appears to be turning against aggressive EBT schemes now as a cumulative result of the disguised remuneration rules, the Glasgow Rangers case, the introduction of Accelerated Payment Notices (“APNs”) and the decision of the GAAR Panel in August 2017 on EBT gold bullion schemes. As a result, it is now relatively settled that aggressive EBT schemes do not work and will attract a tax liability which HMRC can demand be paid before any appeal is heard. Future plans in the draft Finance Bill 2019 will make directors personally liable for such tax liabilities.
Gold Bullion EBT Schemes
A gold bullion scheme is a more aggressive type of EBT scheme. Such a scheme was the subject of a recently reported case – Secretary of State for Business, Innovation and Skills v Akbar and others  EWHC 2856 (Civ). In this case, the claimant (Secretary of State) brought proceedings under section 6 of the Company Directors Disqualification Act 1986 (“CDDA”) against the company’s directors. Under section 6, the Court shall make a disqualification order against a director of a company which at any time has become insolvent (whether while he was a director or subsequently) and his conduct as a director of that company (either taken alone or taken together with his conduct as a director of any other company or companies) makes him unfit to be concerned in the management of a company. The case highlights the perils for directors and the possible claims that insolvency practitioners may have against them where an EBT has been operated by the Company pre-insolvency.
The company in question was Mumtaz Food Industries Limited (“MFIL”), which operated the well-known Mumtaz restaurant in Bradford, along with a wholesale and retail arm for the sale and supply of Indian food. MFIL entered liquidation on 24 May 2013.
The action brought by the Secretary of State related to a group reorganisation in 2012, in which MFIL’s directors sanctioned various transactions that were of questionable benefit to the company. One of these transactions involved a distribution to Dr Gul-Nawaz Khan Akbar (“Dr Akbar”) through the mechanism of purchasing gold bullion for his benefit as part of the operation of an EBT scheme. Mr Akbar was a director of MFIL at the time. As discussed above, gold bullion EBT schemes are a particularly aggressive form of EBT tax planning. In its simplest form, the company will make a cash contribution into an EBT which will use the cash to acquire gold and then sell the gold on deferred payment terms to a key employee. The employee then sells the gold but never satisfies his payment obligations to the EBT and so has not paid any tax on the gold it received from the EBT.
The Secretary of State submitted that the financial position of MTIL had been such that the payments to the EBT should not have been made, with the result that creditors had been prejudiced and that the defendants had failed to act in the best interests of the company when they had respectively caused and/or allowed it to enter into the gold bullion arrangements. At the time of the distribution, MFIL had allegedly owed seven creditors £465,634.27. The Court found Dr Akbar’s conduct in arranging and effecting the EBT distributions was conduct which made him unfit to be concerned in the management of a company. The Court also made findings against the other directors and disqualified them all for varying terms for overseeing Mr Akbar’s operation of the EBT scheme even though they did not actively receive a benefit from it or action it.
Whilst this case involved an action by the Secretary of State under the CDDA for disqualification proceedings, it provides a useful insight into how the Courts may treat similar directors where an insolvency practitioner brings a claim for misfeasance or to challenge the transaction as a transaction defrauding creditors. If a director can be disqualified for implementing an EBT scheme, it is possible that he can be found guilty of misfeasance etc. and ordered to contribute into the insolvency estate for his actions.
Misfeasance v Disqualification/Compensation Orders
Where these schemes cause particular concern for insolvency practitioners is where a breach of fiduciary duties owed to the company has led to a direct loss to creditors. Following the GAAR Panel finding in August 2017 that essentially these gold bullion EBT structures do not work to avoid tax, it is increasingly more likely that directors will be found to be in breach of their fiduciary duties to the company in implementing such schemes.
Given that it is highly likely that any tribunal or court will follow the decision of the GAAR panel, any claim against the director may rest on the advice given by the tax introducer and whether the director was aware of the risks involved. Post 2011, a well advised director should have been aware of the Rangers EBT case and the political scepticism about these schemes at the time.
However, when considering bringing such a claim, an office holder should consider whether the Insolvency Service may also be looking to seek a Compensation Order against a director alongside their disqualification proceedings. The Small Business, Enterprise and Employment Act 2015 introduced the power for the Insolvency Service to seek a Compensation Order against a director to compensate a particular creditor or group of creditors for his breach of duty or failings which led to his disqualification. It is obvious as to why this could cause conflict with the office holder’s duty to realise assets for the benefit of the general body of creditors. However, the Insolvency Service have in the past stated that they have no intention to usurp the position of an insolvency practitioner in office collecting in such assets for the general body of creditors. In appropriate cases, though, the Insolvency Service may be able to fund a Compensation Order where an insolvency practitioner could otherwise not fund a misfeasance claim, so the Insolvency Service and the insolvency practitioner can support each other to combat this issue rather than cause concern. In the post-Jackson era where insolvency litigation has become increasingly difficult to fund, dialogue with the Insolvency Service to use this power where appropriate is more important than ever.
Points to Consider:
- Was the EBT put in place after 9 December 2010 (when the Finance Act 2011 was announced)? The EBT scheme operated in this case was put in place post the Finance Act 2011, which introduced provisions specifically targeting EBTs to ensure that these schemes were not effective after that date. Had the scheme been implemented before this date, the outcome may have been different.
- Did the company have unpaid creditors falling due at the date that any distribution was made under the EBT? If yes, this may be sufficient to find the director unfit to be in office and therefore potentially liable for a Compensation Order.
- What did the engagement letter from the scheme introducer state? Did the engagement letter warn of risk and advise reserving for a potential tax liability? If so, the director would be hard-pushed to defend a misfeasance claim.
- Was the director of a higher level of qualification? Would he reasonably have been expected to seek a second opinion on the validity of the scheme? Would he be expected to be aware of the political climate at the time? If so, again the director will be judged by his level of expertise.