Having originally intended to expand on our article of 30 June before now, I have taken longer than I had hoped. Part of the reason is that each time we think of this we just see more problems and part of it was to give the regulators and HMRC time to respond. We have seen the recent agreed regulatory announcement and we had hoped that HMRC would comment in detail rather than just issuing a short business briefing, but we are answering so many queries about this that we have to put something on the Blog to ease the pressure.
I’ve set this out in a “Frequently Asked Questions” format, partly because they really are frequently asked questions and partly because it was the only way I could stop my head exploding with all the possible options! We’ve used a bit of poetic licence to include a couple of questions that we have not been asked, but we either think we should have been asked or we wanted to answer anyway. The bottom line though is that at present there are many more questions than definitive answers!
Are HMRC going to appeal? Guidance from HMRC here says “HMRC will not be appealing this decision and subject to the normal rules on input tax adjustment, capping and unjust enrichment, HMRC will pay claims for overpaid tax charged on the services of Insolvency Practitioners that fall within the findings of this Tribunal decision.” We had heard that HMRC would issue guidance by mid-August and we hoped that the above is not all that they would have to say on the subject, but the latest intelligence that we have received suggests that this business briefing will be the extent of their information to IPs on the subject. We understand R3 are pushing them for better and more detailed guidance.
Do we have to seek clearance from HMRC before we take action? Strictly there is no requirement, in that the Tribunal has made its decision and HMRC have not appealed, but given the complexity and current uncertainty we would recommend asking everyone you can, including HMRC. If nothing else the sheer weight of queries may force HMRC , the Insolvency Service and the regulators to develop some form of protocol for you to follow (see below).
What happens to disbursements? We are not VAT specialists, so check to be sure, but we understand that if IVAs are exempt then related disbursement recharges are too.
Does the decision apply to CVAs? From what we can understand of the judgement it was only initially applicable to consumer debt IVAs, but it appears that it will apply to trading IVAs. The Tribunal specifically stated that it was not commenting on whether other insolvency processes might be subject to the same interpretation. I have now read the judgement more than once and the more I read it the more I am convinced that a case could be made out along similar lines for CVAs and possibly even Administrations to be exempt as well. However, until someone takes it to Tribunal or HMRC say something in their guidance, we would not recommend that anybody assume that they are exempt.
What should we do on open cases going forward? We don’t think anybody has been brave enough to say it directly yet, but we think that you should stop charging VAT and reclaim any that you have paid to HMRC to date. We think that you should inform creditors what you are doing, probably in the next annual report. We think it would be prudent to retain any recovered funds and a provision for ongoing VAT until it is really clear that IVAs are exempt and any further advice from HMRC or the regulators has been published. Again we think you should inform creditors that you are doing so.
What should we do on closed cases? This is a lot more tricky. There is no simple statutory route to reopen IVAs. It could be argued that you could reclaim the funds and deal with them on a simple trust basis, but there are other considerations (see the materiality and ethical questions below). The court may feel that it has a general discretion to reopen cases as an equitable solution, but the Insolvency Service and Regulators might feel that there is an argument to deal with the issue as simple trustees to avoid clogging up the courts with applications. This is an area on which further guidance is required from HMRC, the Insolvency Service and Regulators, but in the meantime if you want to go down the trust route to reclaim monies then you should protect yourself by obtaining some legal advice.
What should happen to the funds? HMRC have made it clear that they will consider “unjust enrichment” before paying out any monies. In simple terms this would prevent you from claiming all of the money for your own benefit and in any event (see ethics below) we think that the regulators will consider that your duty of care extends to recovering the money for the individual estates and dealing within the terms of each arrangement. It therefore appears that it is necessary for each estate to receive the refunds that relate to it and those funds should then be dealt with in accordance with the arrangement terms. Please note, however, that we understand that Paymex obtained legal advice, that we have not seen, that may indicate that the funds are not due to the estates, so you should consider taking your own legal advice.
Is there an implied right to draw underpaid/undercharged/written off fees? This will depend on the terms of each arrangement. If outstanding fees stand in priority to other claims on the funds, then you may be able to draw them, but you should consider the impact of this on the “unjust enrichment” policy operated by HMRC.
Can I have the benefit of the VAT paid on nominee’s fees in open cases? Once the funds are returned to the estate you should look at the terms of the proposals and any modifications. We cannot comment on all of the available permutations, but the following discussion may illustrate the difficulty that you face even with the most straightforward modification. The most common modification we have seen is by TIX which amends the nominee’s fees to 5 x contributions, including VAT. In theory then, if the VAT comes back, you could claim it in respect of the nominee’s fees. However, there is an argument that when TIX proposed that modification, they anticipated VAT being deducted and would have approved less if they had known. We really hope that in view of the benefit the creditors will get from the refund relating to supervisor’s fees, and the fact that each practice will have to suffer the implications of being partially exempt (see below), they will not press this point and will allow IPs to keep the refunds, but we would recommend that you check with the creditor who proposed the modification before taking it. Such an agreement should be obtained from the creditor globally in respect of each standard modification rather than on a case by case basis.
Can I have the benefit of the VAT paid on supervisor’s fees in open cases? Again we can only deal with the most common modification, which is that the supervisor be paid 15% of further realisations after deducting the nominee’s fees, excluding VAT. This would result in the VAT being available to creditors. However, we would argue that whilst all the benefit of future VAT exempt fees should go to creditors, the creditors should be asked to approve an appropriate fee for dealing with the VAT reclaim and distribution to them similar to that which we suggest for closed cases below. This is not an attempt to gain more fees for IPs, but a simple recognition of the economic reality of reclaiming the refunds and processing additional distributions. Matters will, of course, be further complicated for those who have accepted conflicting modifications or are subject to overall fee caps that take a different approach to VAT in their wording. The only firm advice that we can give at this stage is that you should look carefully at the approved terms of each arrangement and treat any proposed departure as a variation requiring formal approval.
Can I have the benefit of the VAT reclaim in closed cases? This answer will, in part, depend on whether the case is being reopened or if it is being dealt with on a simple trust basis. In the former, the advice on open cases above would apply. If the cases are not reopened and the monies are dealt with in trust, we are sure that there is a legal precedent available that establishes your right to be paid for dealing with the trust funds, but that should be checked with a lawyer and even then you will have to be very careful. In our risk-averse world we would suggest obtaining approval from the former creditors to a specific fee on a case by case basis. This could, for example, be a lump sum per case or it could be a set percentage of the recovered funds.
If the case failed and the debtor was subsequently made bankrupt then will the money be a bankruptcy asset and payable to the Trustee? What if the debtor has been discharged from bankruptcy? This is so clearly one for the lawyers that we are not going to answer this with anything definitive, and the way to illustrate this is to challenge even the idea that the money will automatically be a bankruptcy asset. A lawyer would need to consider whether the money is a right to monies or newly crystallised asset due to the bankruptcy estate, in which case it would vest in the trustee, or whether it is money that is caught by any trust clause in the arrangement, in which case it would have to be dealt with under the trust clause and might be similar to the closed cases mentioned above. If it is decided that such monies are not caught by any trust clause, the lawyer would then need to decide whether it arises from a right that vested in the trustee and can therefore be claimed post-discharge or just an asset that arises at some date after the Tribunal decision and therefore is due to the trustee only if the debtor is not yet discharged. If it is a bankruptcy asset because it derives from a right of action that vested on appointment or because the bankrupt is not yet discharged, it would be the trustee’s duty to consider recovering it and he is likely to be able to use it just like any other bankruptcy estate asset, in settlement of his costs, fees and charges, so it could fall into the “unjust enrichment” exemption. I hope that shows just how complicated this could all get!
What ethical considerations are there? I’d like to take the easy way out and just say “lots”, but that is not very helpful, so here are a couple that we can see. First, there is the overall question of whether an IP is now liable for not treating arrangements as VAT exempt from the outset. Could it be argued that if Paymex are right, every IP should have been fighting this for years? I think that it is a bit extreme, to say the least, but I think that your ethical consideration should address this issue, even if it is subsequently evaluated as being bunkum. Secondly, is there now an ethical duty on every IP to recover the VAT and distribute it where appropriate, even on closed cases, notwithstanding the fact that it may cost the IP’s firm more then he can recover in fees for doing so and in many cases more than the total VAT refund? Because these are ethical questions, we cannot come up with firm answers and we really hope that HMRC, the Insolvency Service and the regulators will be able to devise some appropriate guidance.
Is materiality a factor? If the supply is exempt, then it would appear that materiality is not a consideration that you should take into account. All incorrectly paid VAT should be reclaimed and all estates should be revisited that fall within the 4 year maximum reclaim period, even if they are closed. As above though, this may be more difficult to achieve in practice. This is the sort of area that we think could be addressed by a protocol agreed between HMRC, The Insolvency Service, the regulators and other stakeholders.
What are the implications for the IP’s past VAT returns? If IVAs are exempt, then each practice that provides them is now at least partly exempt. This means that you have to follow HMRC’s rules in respect of partially exempt supply and your past VAT Returns will need to be adjusted for VAT that you have reclaimed on exempt supplies. In other words, while you may be required to reclaim VAT for the benefit of the IVA estates and may be due some of it in agreed fees, your whole firm may suffer a claim to repay HMRC in respect of expenses where you claimed the VAT back in full at a time when you were partially exempt (e.g. general office overheads etc.). We are not VAT experts, but we understand that there are HMRC rules which set out a de minimis amount of VAT below which threshold you do not need to apply the partial exemption rules. That is something that you would need to check with a VAT specialist or HMRC. We don’t know how the numbers pan out in the real world, but this suggests to us that if you are above the de minimis level then because you may have to share the refunds you receive with the creditors, you may actually end up paying more to HMRC in respect of your revised VAT status than you recover, even if the creditors agree to you having a fee for dealing with the refunds. We understand that there is a statutory duty to get your VAT returns right, which means resubmitting them if you find that they are incorrect, i.e. going back the 4 years maximum that you can submit a VAT reclaim for. Again, this is something that you should either check with HMRC about or take advice from a VAT specialist.
Can I employ agents to do the work for me and pay them out of the estate as a category 1 expense? The answer to this depends on whether the supervisor’s powers as set out in the proposal permit you to employ agents to assist you. If they do then you would have authority to employ agents, but you will need to be careful about the costs involved as the large creditor agents will expect to see some return to creditors from the VAT reclaims made. In addition, if it needs saying, the agents could only be employed to deal with estate monies and they could not charge for dealing with the counterclaim by HMRC resulting from your change in exemption status. We think that a more practical solution would be for the industry to agree a protocol that allows a simplified procedure to operate that would streamline the process and save you having to use agents in the first place.
Do we wish the case had never been brought? Oh Yes!!!
You mentioned a protocol; what did you mean? We think that this is such a mess that HMRC, The Insolvency Service, the regulators and representatives of creditors, specialist IVA providers and smaller non-specialist IPs should come up with an agreed protocol rather than having so many uncertainties that mean that every IP will need to be taking their own advice from lawyers and VAT specialists. We’d be happy to draft something up, but the last time we did that it turned into the Protocol IVA by the time everybody had got at it and that was never what we intended! The sort of things it could cover are: some form of cut-off point, possibly based on the amount of any refunds, whether a case is open or closed and even how many creditors are involved (recovering a few pounds for 10 creditors may not be worth it, but recovering the same amount for just TIX, KPMG and Max Recovery might be worth it); some agreement on nominee’s fees; some agreement on supervisors’ fees; some agreement on an appropriate flat fee or percentage in closed cases; whether closed cases are to be reopened or dealt with on trust; guidance on how everything is to be disclosed to creditors; and an undertaking from HMRC that if the Protocol is followed they will not seek to recover monies that they repay or which IPs do not deduct from now on in open or new cases. This would not be legally binding and anyone who did not adopt the protocol would be free to take their own advice and act accordingly, but there have been examples of such agreements in the past, such as when the Service and HMRC set up separate rotas to clear the PRU backlog. We think that it should even be possible to agree a no claim/no reclaim position with HMRC is respect of all closed cases; so that as long as an IP did not reclaim VAT on closed cases (which is, as above fraught with legal issues and may cost more than it could realise) HMRC would agree to waive any reclaim in respect of partially exempt supply prior to the Paymex decision date, effectively increasing the current de minimis threshold. We could say more, but we would rather test the water with you via feedback to our usual email address and with major voters and the Service before getting too involved.
Finally, a massive disclaimer. We are as confused as the rest of you and this is going to take time to settle down. In a perfect world we would be paid a small fortune by HMRC et al. to design a protocol and we’d have it out before the August holidays are over. In reality, nobody is likely to pay us enough to stick our necks out again and any such proposals would require endless consultation and the whole profession seems headed for a long period of uncertainty. Accordingly, please treat these questions and answers as our reasoned contribution to the debate and not as a statement of law or prescribed action. They are just suggestions. You should not rely on them. You should seek your own advice and even then, until this is all cleared up by the powers that be, we suggest that you ask every time and seek creditor approval for anything you do. Maybe the cost of replying to all of the queries will force a protocol-type solution in the end.
