UK: Unpaid Share Capital In The Context Of Tax-Avoidance Schemes: Shareholder Liability In Corporate Insolvencies

Last Updated: 26 January 2015
Article by Daniel Moore and Tom McLachlan

INTRODUCTION

Over the course of the past 12 months we have encountered a number of compulsory liquidations where HM Revenue & Customs ("HMRC") has taken proactive steps to notify liquidators in relation to unpaid share capital claims arising from certain tax avoidance schemes.

In the cases that have been identified by HMRC, the unpaid share capital is the result of a specific tax avoidance strategy that a significant number of companies have sought to take advantage of and which HMRC is currently investigating. A number of companies that have implemented the scheme have subsequently been wound up by the Court and in those compulsory liquidations there are significant sums due from shareholders in respect of unpaid share capital.

The tax avoidance scheme may be referred to as an "E-shares scheme" as the scheme creates a new class of shares labelled "E-shares". There may be similar schemes that go by different names.

A SUMMARY OF THE SCHEME

The schemes which we have encountered are often structured as follows:

  • The company in question pays an existing employee (who is often a director and a shareholder) say £100,000 on a legally binding condition that at the same time the employee (in his capacity as a shareholder) subscribes for shares in the company (i.e. "E-shares").
  • The shares in the company that are subscribed for have a nominal value of £100,000 and are set up as a new class distinct from the company's existing share capital. However, only 1% (£1,000) is paid in respect of the share premium. Therefore £99,000 remains unpaid in respect of the new share capital.
  • The tax advisers that offer the scheme explain that of the sum of £100,000 paid to the employee, £99,000 can be deducted from the company's profit and loss account and the company therefore receives tax relief on that sum. Further, the payment of £100,000 to the individual should not be taxable in their hands as it relates to a binding contract to purchase the new class of shares. We understand these purported tax benefits are being investigated by HMRC.
  • Ultimately, the individual holds shares with a value of £100,000 of which only £1,000 has been fully paid up and also receives a cash payment of £100,000.

The relevance of this tax avoidance scheme to liquidators of such companies is as follows:

  • A claim by a liquidator for unpaid share capital is a debt claim and therefore in the absence of a dispute it is not necessary to seek an order of the Court in order to ascertain i) liability; or ii) the quantum of the liability.
  • The tax avoidance scheme in question often also results in significant funds being paid from a company to an employee of the company who will also be a shareholder. This raises the possibility of claims for misfeasance, transactions at undervalue and preferences.
  • A significant number of small companies have sought to take advantage of the tax avoidance scheme to the extent that HMRC is proactively investigating all tax avoidance schemes of this nature and is keen to work closely with office holders to recover funds for the benefit of liquidation estates.

POTENTIAL CLAIMS BY A LIQUIDATOR

CONTRACTUAL DEBT CLAIM IN RESPECT OF UNPAID SHARE CAPITAL

A liability of a shareholder to a company in the event of a winding up is limited to the value of his unpaid share capital. This is clear from section 74(2)(d) of the Insolvency Act 1986 ("the Act") which states as follows:

"in the case of a company limited by shares, no contribution is required from any member exceeding the amount (if any) unpaid on the shares in respect of which he is liable as a present or past member".

Any sum outstanding in respect of share capital is a debt due to the company pursuant to section 80 of the Act which states as follows:

"The liability of a contributory creates a debt (in England and Wales in the nature of an ordinary contract debt) accruing from him at the time when his liability commenced, but payable at the times when calls are made for enforcing liability."

As part of the tax scheme the company will adopt new articles and the new articles will usually state that the new class of shares is treated as called in full from the date the company enters liquidation. The articles will also include a right for the company to demand payment of the unpaid share capital.

From the commencement of the liquidation the liquidator is entitled to be paid the sum due in respect of outstanding share capital and immediately take appropriate enforcement action. For example, a liquidator could instantly serve a statutory demand on a shareholder and pursue bankruptcy proceedings in respect of the debt (as it is not a damages or declaratory relief claim).

OTHER CLAIMS PURSUANT TO THE ACT

In addition to a contractual debt claim for the unpaid share capital, the structure of the tax scheme may also give rise to ancillary claims for liquidators as follows:

SECTION 212 OF THE ACT - MISFEASANCE:

Depending upon the facts of the case there may be grounds to investigate whether the company's directors have been misfeasant in paying significant funds from the company (for example, the payment of £100,000 referred to above).

SECTION 238 OF THE ACT - TRANSACTIONS AT AN UNDERVALUE:

Although less straightforward, there may also be grounds to investigate whether the payment of funds to an employee is a transaction at an undervalue as the consideration in return for the payment may be difficult to substantiate. The nature of the scheme is such that the payment will be made to an existing employee (who is also a shareholder) and there is immediately the issue of whether the employee is offering sufficient consideration (an obligation to take further issued shares of questionable market value) in return for the benefit received (a significant cash payment from the Company).

SECTION 239 OF THE ACT - PREFERENCE TRANSACTION:

A final potential claim may arise when the payment of funds to the individual constitutes a preference transaction if the individual in question is also a creditor of the company. Such tax schemes are often used by owner-managers in small enterprises who may also have other dealings with the company such that they may in fact be creditors of the company.
Such claims would typically relate to the payment of funds from a company to individuals in connection with the tax scheme on the basis (as with section 238 of the Act) that the Company could be proven to be insolvent at the relevant time by virtue of the shareholding, the party would also be treated as 'connected'.

CONCLUSION

Office holders should always be alert to the potential prospect of shareholders being liable for unpaid share capital. In the context of the tax avoidance scheme referred to above the value of the unpaid share capital can be significant and there may also be ancillary office holder claims in relation to payments from the company to individuals that may result in further recoveries for the insolvent estate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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