Harry Potter themed gift shops and other London ‘tourist tat’ retailers have prompted a closer look from Joe Powell, the relatively new Member of Parliament for Kensington & Bayswater. He’s less interested in a Big Ben desktop clock than in allegations of souvenir sellers close to Westminster, and in his own neighbouring constituency, avoiding paying corporation tax, VAT or business rates by regularly closing their limited companies and reappearing with new ones.
‘Phoenixing’, after the mythical bird rising from the ashes, refers to directors continuing the same business through a new company but without the debts of the former entity. Sometimes the business may even be sold as a going concern in a pre-pack administration managed by an Insolvency Practitioner. Around 1,000 such new companies are estimated to have emerged every month in recent years. The process of ‘phoenixing’ is legal, as long as very strict rules are followed – critically, demonstrating that creditors’ interests are maximised.
The main considerations for directors are:
- It must be clear that the previous company cannot be rescued.
- Its assets must be sold at a fair price in the interests of creditors.
- Proper records must be kept during the process.
- Directors must observe their fiduciary duties under the Companies Act.
- The new company must use a different name to avoid misleading customers and creditors – unless the same name is Court approved.
Unsurprisingly – and rightly – HMRC is alert to ‘phoenixing’ situations which suggest a company has been wound up to avoid paying tax. It will apply the following tests to liquidated companies to establish whether avoidance was the motivation:
- The distributing company must, in the two years before liquidation, be a ‘close company’, i.e. have five or fewer participants.
- Shareholders must hold a minimum of 5% equity and voting interest pre-liquidation.
- Shareholders in the new company are seen to be involved in a similar business within a two-year period of shutting down the original company.
- ‘Reasonable’ evidence suggests that the liquidation was prompted by a chance to pay reduced income tax.
Given the tight rules, ‘phoenixing’ understandably raises suspicions about directors who might have forced their companies into insolvency, only to then purchase back company assets through a new company and leave behind any liabilities in the old entity. Creditors, suppliers and other stakeholders immediately lose out, with no contractual claim against the new company. Unfortunately, some directors do indeed set out to commit insolvency fraud.
There is life after insolvency for some businesses – as distinct from the companies containing them – but directors continuing to trade in effectively the same way yet in a different guise must tread very carefully.
Those wanting to stay on the right side of the law in this potential minefield should take professional insolvency advice throughout the process. Buchler Phillips welcomes exploratory discussions with directors aiming to migrate their former businesses to new incorporated entities.
This article is written by Alice Fanner, Manager at Buchler Phillips, an independent boutique firm, with an impeccable Mayfair London heritage, specialising in corporate recovery, turnaround, restructuring and insolvency.