Disguised Remuneration and ‘Prohibited Purpose’
The Court of Appeal has provided important clarification of the meaning of ‘prohibited purpose’, in the context of tax avoidance schemes and disguised remuneration1. However, care must be taken to avoid any arguments that those setting up such schemes may have intended to defraud creditors.
Prohibited purpose
The Insolvency Act 1986 (section 423) concerns transactions defrauding creditors. It prohibits a party from disposing of assets deliberately to frustrate their creditors, such as HM Revenue & Customs. The provisions allow creditors to claw back assets that have been put beyond reach for a prohibited purpose. The underlying policy is that debts are to be paid before transfers and gifts are made.
What’s the background?
An umbrella company was set up to operate a tax mitigation scheme. The ‘employees’ would receive most of their earnings as loans from an offshore employee benefit trust without any deductions for income tax or national insurance contributions.
HMRC challenged the scheme and assessed the company as liable for unpaid taxes of £2,238,057.72 for the two tax years to 2009-2010. The company then went into liquidation and the liquidator brought several applications under s423 against the scheme’s participants on grounds that the transactions were at an undervalue; and the scheme was intended for the prohibited purpose of avoiding tax liabilities.
The High Court agreed that the transactions were at an undervalue, however the prohibited purpose element was missing. The liquidator appealed, drawing a distinction between "tax mitigation" and "cases of unacceptable tax avoidance".
The outcome
The liquidator argued that this case involved unacceptable tax avoidance as the company had sought to ‘disguise’ payments of remuneration to its employees in a completely artificial arrangement. The Court of Appeal was not convinced, saying that the difference between the two is not the purpose, but the means by which that purpose is put into effect.
It held that entering into a transaction in order to ensure a liability does not accrue does not involve a prohibited purpose under s423.
The liquidator also argued, in the alternative, that the Company's purpose was to make it more difficult for HMRC to recover tax in the event the scheme was ineffective to avoid a liability to tax arising. However, there was no evidence to support that alleged intention. The appeal failed.
What does this mean?
Tax avoidance, such as disguised renumeration, is subject to the general anti-avoidance rule to numerous targeted anti-avoidance provisions.
We strongly advise that specialist advice is taken from expert tax or commercial lawyers if you’re considering or reviewing any existing such scheme.
If you would like us to cover an issue in the next NGM Tax Law Newsletter, we would be delighted to hear from you
!Purkiss v Kennedy [2025] EWCA Civ 268