One of the primary reasons many business owners choose to incorporate their businesses and become a limited company rather than a sole trader is to benefit from the limited liability it brings.
Limited liability provides the protection that, if the business were to fail, the directors would not be held personally liable for the company’s debts.
However, in the case of limited company tax liabilities such as VAT, PAYE, National Insurance contributions and corporation tax, company directors can be made personally liable in certain instances if payments are not made.
When can Company Directors be made Personally Liable for Unpaid tax?
It is not unusual for companies that are in financial distress to accumulate VAT, PAYE and National Insurance contributions arrears. It’s often the case that struggling companies do not make a profit, which makes corporation tax arrears less common.
Ordinarily, if the company were to become insolvent, HM Revenue & Customs (HMRC) would not be able to recover the unpaid tax from the company directors personally. However, HMRC does have the power to make limited company directors personally liable for unpaid taxes where evidence shows the failure to make payments was deliberate or the result of neglect or fraud.
Two things often described as HMRC powers are not. Paying yourself dividends the company had no distributable reserves to pay, or paying family and friends ahead of HMRC, are matters for a liquidator rather than for HMRC. The first is an unlawful dividend, recoverable from you. The second may be a preference under section 239 of the Insolvency Act 1986. Both can leave you paying money back, and HMRC as the largest creditor will often be the one pressing for it, but the claim belongs to the office-holder and is decided on insolvency law rather than tax law. The tax routes below are separate, and each has its own conditions.
Directors Liability for HMRC Debts
VAT
Two different powers get called personal liability for VAT, and they reach different amounts. Where a penalty is charged on the company for a deliberate inaccuracy and that inaccuracy is attributable to an officer, paragraph 19 of Schedule 24 to the Finance Act 2007 lets HMRC recover up to 100 per cent of the penalty from that officer. That is the penalty, not the tax. Separately, where there is avoidance or evasion and the company is insolvent or heading that way, HMRC can give a joint and several liability notice under Schedule 13 to the Finance Act 2020, which does make the person jointly liable for the tax itself. Another power HMRC has in relation to VAT liabilities is to demand VAT security for any future businesses the director of the insolvent company is involved in. That VAT security can represent a significant sum of money, which can make it difficult to start a new business.
PAYE
Under regulation 81 of the PAYE regulations, where a determination against the employer goes unpaid, HMRC can direct that the employee pays the tax that should have been deducted, provided that employee received the payments knowing the employer had wilfully failed to deduct. In an owner-managed company that employee is normally the director, which is why it is thought of as a director power. It reaches the tax on their own payments, not the whole PAYE bill. For that reason, this power is usually applied in small owner-managed businesses where the director has control over the company’s finances.
National Insurance Contributions (NICs)
Section 121C of the Social Security Administration Act 1992 lets HMRC recover unpaid Class 1 National Insurance contributions, with the interest and penalties that go with them, from an officer of the company where the failure to pay is attributable to that officer’s fraud or neglect. Unlike the PAYE direction, it is not confined to the officer’s own pay: the notice covers a share of the company’s unpaid contributions reflecting their culpability, with interest and penalties. It applies to National Insurance only.
A personal liability notice (PLN) is the document issued by HMRC to make a director aware that the debt has been transferred to them personally. It will specify the amount of NICs the director is personally liable for; the penalties and interest that apply, and any statutory interest payable on the debt.
Corporation Tax
If a business is struggling financially then, generally speaking, it will not be making a profit and no corporation tax will have to be paid. Some struggling companies do build up corporation tax debts, and HMRC will enforce against the company in the usual way. There is no general power to move a corporation tax debt onto a director. Where a person is made liable it is through a named route: a joint and several liability notice under Schedule 13 to the Finance Act 2020, or the officer liability in paragraph 19 of Schedule 24 to the Finance Act 2007 where a penalty for a deliberate inaccuracy is attributable to them. Payments made to directors instead of HMRC are more likely to surface as a liquidator’s claim: an unlawful dividend, a preference, or an overdrawn loan account.
Need advice?
If your limited company is struggling financially and you have unpaid tax debts the business cannot pay, we’d advise you to contact our team immediately. Any initial consultation is completely free and we can help you consider all the options available to you. To find out more, contact AABRS® today.