Contractors, what is phoenixing and what are the consequences?

It’s no surprise to us at the frontline of limited companies closing and opening that ‘Phoenixing’ was a focus of the National Audit Office probing HMRC this month.

Not because the mythical bird based on the term raises cyclically, but because that BoE-anticipated spike in insolvencies will – unfortunately -- provide fertile conditions for phoenix companies, writes Gareth Wilcox, partner at Opus Restructuring and Insolvency.

Refresher: What is ‘Phoenixing’?

Phoenixing is the practice of one indebted limited company being closed (either by liquidation or dissolution), and another taking its place, usually operating using the same assets and/or business model -- as if it was rising or being reborn like a phoenix from the flames. Yet crucially, this transition is made with the underhanded intention of avoiding debt, or leaving debts behind, accrued in the initial, previous company.

What’s the problem with Phoenixing?

Insolvency legislation exists to enable directors of companies burdened with unmanageable debt to move on from the business failure and start over in a new venture.

This is not an example of the legislature being benevolent of course; rather, the government wants businesses to be paying money into the exchequer once more.

The problem is; this can be open to abuse and for creditors (particularly HMRC as a creditor in almost all such scenarios), they get left ‘carrying the can,’ financially, for rogue directors. While there is no prohibition on an individual being director of other companies while another is subject to insolvency proceedings, the practice of ‘phoenixing’ is something that HMRC is keen to clamp down on.

With the possibility of an increase in business failures on the horizon following the Covid-19 pandemic, and the chancellor facing the anticipated burden of paying out under the government-backed support measures, it is clear why this matter is now receiving renewed focus.

In fact, as mentioned at the outset, the NAO chose phoenix companies as one of two taxpayer populations to look into, to determine how well HMRC understands how the pandemic will affect the amount of work tax officials need to do to manage debt. See the NAO’s full report here, but in short, the NAO said: “In both cases, we found that HMRC had a limited understanding of how the pandemic would impact the scale of what HMRC would need to do.”

What can HMRC do against phoenix companies?

One of the most serious sanctions available to HMRC is that is has the power to issue a Personal Liability notice to a director, which has the effect of the individual becoming personally liable for certain company taxation liabilities.

A Personal Liability Notice may be issued by HMRC if they consider that an officer of the company has caused an underpayment of contributions through fraud or neglect.

Such a PLN can arise where a company has failed to pay taxes on time and where HMRC is of the view that the failure to pay the tax liability was attributable to serious levels of neglect or fraud. Often, this can include where there have been phoenix companies with a history of non-payment of tax liabilities.

This is clearly a huge interruption to the concept of ‘limited liability’ (the main reason contractors incorporate), and HMRC will only usually seek to rely on these powers where there is demonstrable evidence that steps were taken to deliberately avoid tax being paid.

A slightly less draconian option, but still one contractors should beware of, is that HMRC may require a security (or bond) payment from a successor company following a failure, to insulate from the risk that a further bad debt is suffered.

Either of these measures can be challenged. And neither is likely to arise if a relatively small debt is suffered by HMRC as a ‘first offence.’ But there is also potential criminal consequences for tax evasion, of course.

Are there other consequences for phoenix company directors?

In addition, evidence of ‘Phoenixing’ is a matter which is taken into account when disqualification proceedings are being considered against directors.

Similarly, any appointed insolvency practitioner is required to include such evidence when reporting on the conduct of directors as part of their appointment. As such, there is a possibility that such conduct could lead to a director being disqualified from acting as a director.

Furthermore, a director who reuses a similar company name may find themselves personally liable for the debts of the successor business.

Will HMRC have the resources to investigate?

This is a question that seems to be coming up repeatedly, with an upturn in insolvencies expected to stretch the resources of an already-stretched HMRC and associated government departments.

Yet with HMRC having recently announced how it intends to approach the mis-use of covid support measures, and given the tax office has set up specific teams to investigate the matter, it is clear that this is something the government intends to focus on.

Combining the above HMRC intent with the seriousness of the consequences for falling foul of the legislation, I would definitely not suggest that a director runs the risk. It is worth bearing in mind that (presuming recoveries are made), these departments will be self-funded and are designed to return monies to the exchequer, and at a time when they are badly needed.

Final thoughts

As always, limited company contractors in financial difficulties will be well-served to take advice from suitably qualified professionals, such as their accountant, an insolvency practitioner or a solicitor.

Taking reputable and tailored advice will ensure that difficulties are handled properly, minimising the risk of criticism, or worse – consequences, for the director involved. This may in appropriate circumstances include the director (or another company) buying the assets and/or business of an insolvent company (for proper value). However, that should only be done with the oversight of a licensed insolvency practitioner.

All in all, one of the very, very last things I would recommend to contractors is to set up a new company to trade, and abandon the old company to its fate. With phoenixing, the old adage rings true that one bird in the hand is absolutely worth two in the bush. And quite apart from this ‘in with the new, to get out of the old and indebted’ approach to company formation being a flagrant disregard of a director’s duties to the previous company and its creditors, the consequences can be severe and are only likely to get worse with the passage of time.