Conflicting decisions in two cases relating to unpaid PAYE

Directors’ loan accounts and unpaid PAYE liabilities

Two recent First-tier Tribunal cases covering similar situations highlight the potential tax risks arising for owner managers of financially struggling companies unable to pay dividends in order to clear director’s loan account balances.

It is fairly normal practice for many owner managed businesses to draw money from the company during the year and record these within the director’s loan account with a payment of an approved small salary and larger amounts of dividends credited to the loan account to extinguish the loan account indebtedness. In both cases; Phillip Marsh and David Price v HMRC TC05288 and Stephen West v HMRC TC05285, because of financial difficulties, dividends could not be declared by each company but larger salary payments were paid instead with PAYE deductions accounted for but not paid to HMRC. The PAYE debts were pursued by HMRC from the directors (Appellants) themselves via PAYE Reg 72 and NIC Reg 86 determinations to which appeals were made by the appellants. One appeal was dismissed but the other allowed albeit on the Judge’s casting vote in a split decision. The facts and the decisions will therefore be of interest to those advising OMBs in this area.

Facts of the cases

Marsh case

Both Phillip Marsh and David Price were equal shareholders and directors of a company providing gardening and cleaning services. The business was initially successful and turnover increased rapidly. During 2008 and 2010 other businesses were acquired by the company with the support of a bank overdraft and invoice discounting services.

Historically, the Appellants had received small salaries (£6,000 pa gross) from the company with the majority of their income paid in the form of dividends. There was no pre-determination entitlement to salary and it would be usual for the directors to take round sums and then for subsequent adjustments to be made via the loan accounts.

In 2010/11, the Appellants increased their salaries to £102,000 each, being recorded as taking £8,500 per month with a total cost to the company, including NIC of £228,600. At this time, the company was experiencing cash flow difficulties and with a reduction in the bank overdraft and termination of the invoice discounting facility, matters worsened and in April 2011, the company went into administration. PAYE deductions were calculated by the company and figures entered onto form P35 for 2010/11 but no tax or NIC was paid to HMRC in respect of the salary payments.

The Appellants said that large salaries were taken to facilitate mortgage applications and that it was never the intention not to comply with PAYE/NIC regulations and that they believed the cash flow problems would be temporary. HMRC questioned how such salaries could be paid in the same period when the company was unable to afford payments under PAYE to HMRC. HMRC believed that the Appellants were aware that the company was not correctly operating PAYE in respect of drawings and therefore a wilful failure to pay over amounts to HMRC had occurred.

The Appellants case was based on the fact that under Regulation 72(5) PAYE Regulations 2003, there must be a wilful failure to deduct the correct amount. The argument made was that there was a difference in failing to deduct sufficient tax from a failure to actually pay the amounts and that the failure of the latter does not satisfy the requirements of Reg 72 which requires a failure to deduct. In line with the case of Prowse and Prowse v HMRC [2012], the payslips and P11 working sheets were sufficient evidence that the directors had drawn net amounts after deductions had been made by the company and it was the sudden demise of the company which prevented it from making the payments.

HMRC took the view supported by the case of Regina v Commissioners of IR ex parte McVeigh that book-keeping entries without accompanying payment of tax and NICs to HMRC did not constitute the operation of PAYE. As both were responsible for the payroll and joint signatories to the bank account the directors were aware that the company wilfully failed to deduct the relevant payments. They had simply chosen not to pay HMRC.


The tribunal found that the appellants continued to take salaries despite the company’s profits not being able to financially support this. They had overall control of the company and were therefore in a position to ensure that PAYE was operated correctly. Regulation 72 specifically refers to liability arising where the deductible amount exceeds the amount actually deducted. They were not able to provide proof that tax and NIC had been deducted and as the failure was deliberate the Tribunal was satisfied the directions by HMRC were properly made.

West Case

Simon West (Appellant) was the sole director and shareholder of a company trading in the selling of satellite space to the telecoms industry.

The Appellant drew money from the company, recorded those drawings in the director’s loan account, with subsequent adjustments made predominantly by way of dividends approved and credited to the loan account at the end of the year.

Towards the middle of 2011, the Appellant became concerned about the company’s business and his exposure personally if the company traded while insolvent. He sought advice from an insolvency practitioner who advised him to put the company into liquidation and to be paid wholly by way of salary given the company had no reserves to pay dividends. The Appellant instructed his accountant to prepare accounts showing an amount of director’s remuneration which, after deducting PAYE and NICs, would be sufficient to offset the drawings on the loan account. The tax and NIC due on the grossed up salary was left outstanding as an amount owed to creditors.

After a period in which HMRC were unsuccessful recovering the debt from the company, HMRC formally transferred the debt to the Appellant and pursued via Regulations 72 and 86 against which appeals were made.

The Appellant’s argument supported by Garforth v Newsmith Stainless Ltd [1978] was that there did not have to be a movement of cash to the employee for deduction to have taken place. A credit to the loan account was regarded as payment point for PAYE. Counsel for the Appellant argued that the comments put forward in the McVeigh case that book-keeping was not evidence of deduction without payment was incorrect. If that proposition was correct then any unpaid liabilities of all such cases would be transferred to employees.

HMRC’s case was centred on the McVeigh case. In addition, HMRC contended that the ‘paper exercise’ was undertaken simply to clear the overdrawn loan account preventing the liquidators from recovering the debts from the directors. As the sole shareholder and director the Appellant was fully aware of the outcome of instructions to the accountants in repaying the loan account.


The two members of the Tribunal panel did not agree on this case so the Judge exercised his casting vote in favour of the Appellant. Based on accounting entries and the Summary Statement of Affairs included in the joint liquidators’ Report for Meeting of Creditors, PAYE and NIC liabilities had been clearly quantified in the company’s records. Thus the indebtedness to HMRC resulting from grossing up the amount paid to clear the loan account was acknowledged, thereby confirming the deduction of the tax and NIC.

The judge was satisfied that as tax was properly deducted the first precondition to the operation of Reg 72 for tax purposes was not fulfilled. In relation to NIC, given the timing of the payment discharging the loan account it was not open to the company to pay the NIC due and on that basis there had been no wilful or deliberate failure by the company to pay NIC. As a result, Reg 86 did not apply. The appeal was therefore allowed. It is interesting however that the dissenting member of the Tribunal took the view that the book entries were ‘entirely notional’ and that the company had failed to discharge its obligations to deduct PAYE and make payment and did so at the instigation of the Appellant.

Important aspects of the cases

In both cases the Appellants were relying on the accounting and other documentary entries to support the argument that deductions had been made. The fact that this argument was accepted in one case will give advisers and clients some encouragement that preferential payments could be made to owner managers of failing companies about to go into liquidation at the expense of other creditors such as HMRC who are unable to receive payment from the liquidator. However, given this potential unfairness, an appeal against the West decision from HMRC would not be surprising.

For further information please contact the TaxDesk on 0845 4900 509 and ask for Martin Mann.