Directors of limited companies are generally not personally liable for unpaid corporation tax as limited liability usually protects them. A company is a separate legal entity and limited liability is one of its core features.

However, in some circumstances, HMRC may pursue directors personally. The risk increases where non-payment of corporation tax is due to deliberate behaviour, negligence or fraud. If directors pay themselves rather than settling their company tax bills then HMRC may view this as evidence of misconduct. Similarly, if the business pays connected creditors such as family or friends but does not pay its corporation tax then the directors could face personal claims. HMRC is more likely to pursue directors for payment under a liquidation where HMRC is a preferential creditor.

Fraudulent and wrongful trading

Under insolvency law, directors can be personally liable if they engage in fraudulent trading or wrongful trading.

• Fraudulent trading occurs where a business operates with intent to defraud creditors or for any fraudulent purpose. If proven, the court can order directors to contribute to the company’s assets personally.
• Wrongful trading has a lower threshold applying if directors continued to trade at a time when they knew, or ought reasonably to have known, that there was no reasonable chance of avoiding insolvent liquidation.

If corporation tax increases during the period where fraudulent or wrongful trading is proved, a liquidator may seek a court order requiring directors to contribute personally. Although this action would be brought by a liquidator rather than HMRC directly, unpaid corporation tax often forms a substantial part of any claim.

Unlawful dividends

Shareholders are generally protected by limited liability. However, if dividends are paid unlawfully, shareholders and directors who knew or had reasonable grounds to believe that the distribution was unlawful may be required to repay.

Under the Companies Act 2006, dividends may only be paid out of distributable profits. These are defined as accumulated realised profits less accumulated realised losses. Consequently, a dividend may be paid in a loss-making year provided sufficient retained profits are brought forward. Alternatively, if there is a profit for the year but past accumulated losses exceed total realised profits then a dividend cannot be paid.

In addition to the substantive requirement for distributable reserves, proper corporate procedures must be followed. If a director authorises a dividend when there are insufficient reserves, and knew or had reasonable grounds to believe the payment to be unlawful, then the dividend may be repayable. This can happen even if the director was unaware at the time that the accounts did not support the payment.

A liquidator may seek recovery from shareholders should it be found that a dividend was paid but corporation tax was unpaid and the payment contributed to the company’s insolvency. In owner-managed companies, where directors and shareholders are often the same individuals, the exposure can be significant.

Capital distributions following asset disposals

Further risk may arise where capital distributions are made to directors following asset sales. A capital distribution is defined as a distribution in money or money’s worth that is not treated as income in the hands of the shareholder, either because it falls outside the income tax definition of a distribution or because it is paid to another corporate shareholder.

Where a company disposes of assets and realises chargeable gains, corporation tax may arise on those gains. If the company then makes a capital distribution to a shareholder and fails to pay the associated corporation tax within six months of the due date, HMRC has statutory powers to pursue that shareholder. An assessment may be raised on the recipient within two years of the corporation tax due date.

Practical point

Trading whilst insolvent, paying connected parties, paying unlawful dividends or making distributions without paying the corporation tax due can all lead to personal claims on the directors. Directors should prioritise paying corporation tax, pay dividends only from distributable reserves and check that the company is solvent before paying dividends.

Partner note:

Insolvency Act, s417
TCGA 1992, s189, s286
Companies Act 2006, s830, s847
HMRC Company Taxation Manual CTM15205