Tax Avoidance vs. Asset Concealment: Purkiss v Kennedy Limits HMRC’s Insolvency Powers

In a setback for HMRC’s efforts to recover tax via insolvency proceedings, the High Court case Purkiss v Kennedy EWHC 1081 (Ch) saw a liquidator’s attempt to claim funds from participants of a failed tax avoidance scheme ultimately dismissed. The liquidator, acting for Ethos Solutions Limited, sought to recover unpaid PAYE and National Insurance Contributions (NICs), arguing that the scheme was a transaction at an undervalue, designed to prejudice HMRC.

However, the court ruled that while the scheme did result in unpaid taxes, it did not meet the threshold for a transaction defrauding creditors under section 423 of the Insolvency Act 1986, as there was no evidence of an intention to deliberately put assets beyond HMRC’s reach. This outcome underscores the challenges HMRC faces when pursuing tax recovery through insolvency law and highlights the importance of proving fraudulent intent, a crucial point for individuals and businesses involved in tax disputes.

Tax Avoidance Schemes and HMRC Enforcement: Purkiss v Kennedy

The ruling in Purkiss v Kennedy clarifies the scope of insolvency law in the context of tax avoidance schemes, presenting new challenges for HMRC’s enforcement strategy. The case, concerning a liquidator’s claim under section 423 of the Insolvency Act 1986, examined transactions allegedly defrauding creditors in relation to an umbrella tax avoidance scheme. The High Court’s decision offers crucial insights for tax litigation, tax disputes, and future tax avoidance cases.

Ethos Solutions Limited and Tax Avoidance

Ethos Solutions Limited operated a tax avoidance scheme where self-employed individuals became employees of the company. Payments were channelled through an offshore employee benefit trust (EBT) to avoid Income Tax and National Insurance Contributions (NICs). The scheme worked by having individuals who provided services as consultants become employees of Ethos Solutions. The company then paid the bulk of their remuneration to an offshore EBT, from which the individuals received loans. The intention was to avoid income tax and NICs, but the Supreme Court later ruled such schemes ineffective in Rangers (RFC 2012 Plc v AG for Scotland UKSC 45). Following this, HMRC assessed the company for PAYE and NIC liabilities of £2.2 million in 2012, leading to its liquidation. The liquidator then sued 23 scheme participants under section 423 of the Insolvency Act 1986, arguing that the scheme was a transaction at an undervalue intended to prejudice HMRC by avoiding tax.

Tax Avoidance vs. Tax Evasion

Tax avoidance refers to legally minimising tax liabilities by using available tax reliefs and planning strategies, such as contributing to pension schemes or claiming business expenses. Tax evasion, on the other hand, involves illegal actions, such as hiding income or falsifying documents, to evade tax obligations. The case of Purkiss v Kennedy falls under tax avoidance, where a scheme was used to reduce tax liabilities, though later deemed ineffective.

What is Section 423 of the Insolvency Act 1986?

Section 423 of the Insolvency Act 1986 is designed to prevent individuals or companies from moving assets out of reach of creditors in a way that prejudices their ability to recover debts. It applies when a transaction is deemed to have been made with the intention of defeating creditors, including HMRC in cases involving unpaid tax liabilities.

High Court’s Decision

The High Court addressed three main legal issues:

1. Was the Scheme a Transaction at an Undervalue? The court ruled that the scheme was indeed a transaction at an undervalue because the company incurred substantial tax liabilities exceeding the value received.
   
   A transaction at an undervalue, as defined by Section 423 of the Insolvency Act 1986, occurs when a company provides consideration (payment, goods, or services) that is significantly more valuable than what it receives in return. In simpler terms, it’s like selling a valuable asset for a fraction of its worth. For example, if a company sells a £100,000 property to a friend for £10,000 before going insolvent, creditors could challenge this transaction. In this case, Ethos Solutions was deemed to have entered into such transactions because the tax liabilities they incurred far outweighed the fees they collected.
2. Did the Scheme Have a “Prohibited Purpose” to Defraud HMRC? The court found no prohibited purpose, as the scheme aimed at tax avoidance, not asset concealment, and there was no evidence of deliberate intent to defraud HMRC.
   
   A prohibited purpose refers to the intention to put assets beyond the reach of creditors or to prejudice their interests. The court distinguished between tax avoidance (structuring finances to reduce tax legally) and fraudulent asset concealment (actively hiding assets to evade tax payments). Because Ethos Solutions genuinely believed their scheme was legal, even though it was later proven ineffective, the court determined there was no prohibited purpose.
3. Was HMRC a “Victim” Under s.423? The court rejected the claim that HMRC‘s interest in collecting tax equates to being a creditor prejudiced under s.423, clarifying that avoiding tax is not the same as prejudicing HMRC‘s claim.
   
   To be considered a victim under Section 423, HMRC would have to demonstrate that the scheme directly prejudiced their ability to recover tax debts. The ruling clarified that while tax avoidance reduces a taxpayer’s liabilities, it does not necessarily equate to actively obstructing HMRC’s collection efforts.
   
   Ultimately, the claim was dismissed, clarifying that failed tax avoidance schemes do not automatically trigger liability under insolvency laws.

Download the Judgment Here

Implications for Tax Avoidance Cases and HMRC’s Enforcement Strategy

This decision significantly impacts insolvency-related tax disputes and HMRC’s enforcement strategy against tax avoidance schemes. The key takeaway is that tax avoidance alone is insufficient to establish a fraudulent transaction under s.423. HMRC and liquidators must now prove that the transaction aimed to put assets beyond reach, rather than merely structuring payments to avoid tax.

• Challenges for Liquidators & HMRC: Liquidators must provide clear evidence of intent to frustrate HMRC‘s ability to recover tax, such as internal communications or financial structuring documents.
• Implications for EBT & Loan Charge Cases: Schemes using offshore trusts and discretionary loans may face challenges on tax grounds, but not necessarily under insolvency law, unless asset shielding is evident.
• Impact on Defences in Tax Litigation & Tribunal Appeals: Companies and individuals can argue reliance on tax advice to demonstrate the absence of fraudulent intent, reinforcing the need for HMRC to prove intent.
  • This ruling indicates that relying on professional advice from tax consultants or legal opinions might serve as a valid defense against allegations of dishonesty or fraudulent intent. It underscores the importance of demonstrating that the company genuinely believed the scheme to be lawful and was not intentionally trying to defraud HMRC.
• HMRC May Shift Towards Other Enforcement Tools: Given the difficulty of using s.423 in failed tax schemes, HMRC may focus on direct recovery powers, Personal Liability Notices (PLNs), and actions under the Proceeds of Crime Act (POCA).
  • Personal Liability Notices (PLNs) allow HMRC to shift the tax liability from a company to its directors under certain circumstances. This means directors can be held personally responsible for the company’s unpaid taxes if there is evidence of wrongdoing or negligence.
  • The Proceeds of Crime Act (POCA) is a powerful tool that HMRC can use in extreme cases involving deliberate fraud. It allows them to confiscate assets that are believed to be the proceeds of criminal activity, including tax evasion.

Tax Avoidance Defendants

Businesses and individuals in tax disputes should distinguish between tax avoidance and tax evasion, arguing that they acted on legal advice, the purpose was tax planning, and there was no intention to prejudice HMRC’s ability to collect tax. Cases relying solely on tax avoidance, rather than asset dissipation, are less likely to succeed under s.423.

• Defendants in similar cases should emphasise that they acted on legal advice, genuinely believing the scheme was lawful, and that their primary goal was tax planning, not concealing assets.
• They should also demonstrate that there was no intention to undermine HMRC‘s ability to collect taxes.

A Shift in HMRC’s Approach to Tax Recovery

Purkiss v Kennedy limits the use of insolvency law for tax recovery from failed schemes, unless clear fraudulent intent to put assets beyond reach is established. HMRC will likely adapt its litigation strategy, focusing more on direct tax assessments, personal liability notices, and international asset recovery tools. Defendants can challenge HMRC‘s claims by demonstrating participation in tax avoidance schemes without asset dissipation.

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