Tax, national insurance and VAT debts

CPAG

Tax, national insurance and VAT debts

Income tax arrears

HMRC says it wants to work with clients to find a way for them to pay off their tax debts as quickly as possible but in an affordable way, such as a time to pay arrangement (an instalment payment plan).1 In appropriate cases, HMRC says that it may be able to offer a short-term payment deferral for a set period of time during which HMRC would undertake no collection activity. Where clients are unwilling to discuss a payment plan or fail to respond to communications, HMRC says it will consider using its enforcement powers to collect outstanding tax debts.

Most income above certain fixed limits is taxable. Employees are taxed by direct deduction from their income by their employer (the ‘pay as you earn’ (PAYE) scheme). PAYE taxpayers rarely owe tax on their earned income unless mistakes have been made in the amounts deducted. Self-employed people receive their earnings before tax is deducted and are responsible for paying their own tax directly to HMRC. Arrears are, therefore, more likely to occur with self-employment.

The legal position

Income tax is payable under the Taxes Management Act 1970 and the Income and Corporation Taxes Act 1988 and subsequent Finance Acts and regulations.

Recovery of debt can be by court action, or, more likely, by summary warrant. A summary warrant is a type of court order granted by the sheriff court for certain types of debts that are owed to local authorities and HMRC. They are issued to recover taxes and water and sewage charges and authorise sheriff officers to carry out formal legal debt recovery.

Special features

There are many ways of reducing tax liability, unless it is deducted under PAYE. Self-employed people, in particular, require detailed advice on completing their tax returns and any arrears that HMRC may be claiming. Self-employed people should obtain specialist help either from an accountant, Business Debtline () or TaxAid () if they wish to challenge the amount of any arrears claimed.

A good source of basic information for the self-employed client is the Low Incomes Tax Reform Group ().

It may also be possible to negotiate remission (write-off) of a tax debt if the client’s circumstances are unlikely to improve – eg, if they are permanently unable to work because of ill health or if they have no hope of increasing their income because of their age. This, however, is entirely at the discretion of HMRC. The tax is not permanently written off, but you will not receive further demands unless your circumstances improve unexpectedly.

If the business is continuing to trade, however, it is vital that the client pays any ongoing tax on time and makes arrangements to repay any tax debt, otherwise HMRC can take control of essential goods without a court order and so close down the business.

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National insurance contributions

NI contributions are a compulsory tax on earnings and profits above certain levels (set annually).

The legal position

NI contributions are payable under section 2 of the Social Security Act 1975, as amended by the Social Security Contributions and Benefits Act 1992.

Special features

Employed people pay class 1 NI contributions directly from their wages and so do not build up arrears. Class 2 contributions can be paid by self-employed earners on a voluntary basis. In addition, self-employed people may have to pay class 4 contributions, calculated as a percentage of their profits above a certain level (set annually). After the year end, HMRC sends out demands to self-employed people from whom it has not received the required class 2 contributions.

National insurance classes

The class you pay depends on your employment status and how much you earn.

National insurance class	Who pays
Class 1	Employees under state pension age earning more than £242 a week from one job – they are automatically deducted by your employer.
Class 1A or 1B	Employers pay these directly on their employee’s expenses or benefits.
Class 2	Self-employed people earning profits of £12,570 or more a year. From the 2024/25 tax year, class 2 contributions are only paid on a voluntary basis.
Class 3	Voluntary contributions – you can pay them to fill or avoid gaps in your NI record.
Class 4	Self-employed people earning profits of £12,570 or more a year.

If a self-employed person has also employed someone else, they may be liable for class 1 NI contributions for the employee, as well as class 2, and perhaps 4, contributions for themself.

Demands for payment should be distinguished from the notice sent to people whose contribution record is insufficient to entitle them to use it towards a retirement pension or bereavement benefits. In such cases, HMRC sends a notification giving the opportunity to make up the deficit for a particular year with voluntary (class 3) contributions. This is not a demand for payment.

It is vital that the client pays any ongoing contributions on time and makes arrangements to repay any arrears, otherwise HMRC can take control of essential goods without a court order and so close down a business. In addition, if contributions remain unpaid, the client’s eventual entitlement to contributory benefits, including retirement pension, will be affected.

Value added tax

Value added tax (VAT) is a tax charged by HMRC on most transactions of businesses with an annual taxable turnover of more than a certain limit, set annually. A business must be registered for VAT unless its turnover is below the limit.

The legal position

VAT is payable under the Finance Act 1972, the Value Added Tax Act 1994 and subsequent regulations and amendments. Its scope and level are reviewed each year and changes are often made to the Act following the Budget.

Special features

VAT is a tax on the value added to goods and services as they pass through the registered business. So, although VAT is payable on purchases, this amount can be offset against the tax on the business’s own sales. For example, if the total purchases in a year were £100,000 and the total sales were identical, there would be no value added and no tax payable.

A debt adviser generally encounters VAT debts after a business has ceased trading and the partner or sole trader is left responsible for VAT. Some goods are exempt and the calculation of the amount of VAT is complicated. In most cases, seek help from an accountant specialising in VAT. If VAT is overdue, a surcharge, which is a percentage of the VAT owed, is added to the debt. This amount can be appealed.

Rent arrears

A landlord can recover rent arrears through the sheriff court or tribunal and institute the normal diligence procedures:

•serving a charge for payment;

•carrying out an arrestment of funds or moveable property owned by the tenant in the hands of third parties (including banks); and

•executing an attachment of goods, equipment or money owned by the tenant.

Where it is a company, it can also issue a statutory demand on the business and instigate winding up proceedings.

Some lease agreements may have a reference to ‘summary diligence’ (see here), and this allows them to institute diligence without a court hearing.

If your client struggles to maintain the rent payments, the first option is to discuss this with the landlord. They may be agreeable to a payment plan as the reality is that for them to evict you could lead the premises to be empty for a considerable time in the current economic climate, thus the landlord having no income from the premises – the cities and towns of Scotland are full of empty business premises in our high streets. A more pragmatic approach is required.

Landlord hypothec

Under common law, your landlord has a right known as the ‘landlord’s hypothec’.1s208 BD(S)A 2007 This gives them security over moveable property that you own, which is kept on land or in buildings that you rent from them. It does not allow your landlord to take these items from you.

In practice, the landlord’s hypothec will not benefit your landlord unless you become insolvent. If this happens, the landlord should be paid first out of any money raised by the sale of items covered by the hypothec.

The landlord’s hypothec is only security for rent that is due but unpaid. Your landlord’s rights under the landlord’s hypothec only continue for as long as that rent remains unpaid. However, the right does not apply to:

•items kept in a home, a mobile home, a croft or on agricultural land; and

•property owned by someone other than you; and

•property a third party obtains from you in good faith.

Be sure to check the wording of any lease. If in doubt, seek a legal opinion.

1 s208 BD(S)A 2007 »

The premises lease

Many businesses lease their work premises. In some cases, the unexpired part of a business lease can be a valuable asset that can be realised if the client decides to cease trading or trade from other premises. Professional advice should always be sought on the valuation of such leases. If a lease is to be ‘assigned’ to another person, legal advice should be sought. The permission of the landlord is required. In certain circumstances, if the new tenant fails to pay their rent, the earlier tenant can still be held responsible. To protect against this future liability, it is sometimes better to agree to surrender a lease, even if it may be sellable for a premium.

A landlord may be prepared to accept the surrender of a lease (which ends the tenant’s contractual obligations, such as rent and therefore business rates) if it is clear that they are unlikely to get any more money from a particular tenant. If a client has ceased trading and is likely to remain unemployed for some time, and has responsibility for a lease, you could approach the landlord directly.

Explain that the client is unlikely to meet their contractual obligations and, in some cases, landlords agree to a surrender. You should ensure that you are not dealing with a lease that is of value (perhaps because it forms a small part of a redevelopment site or because the rent has been fixed at a low rate for many future years) before the client gives it away. Specialist advice should be obtained.

Other leases

Many businesses have equipment like photocopiers, electronic scales or games machines that are held on a lease. First, check whether or not the lease is a regulated agreement under the Consumer Credit Act 1974. Many lease documents are complex and specialist help may be required.

A business equipment lease runs for a number of years, during which time the owner of the goods (which may be a finance company) simply charges the rent to use them. At the end of the period, there is no automatic transfer of the goods to the lessee but, in practice, items are often not taken back by lessors. A lease usually contains a provision for early settlement. However, in many cases, this figure is likely to be almost as high as continuing to pay rent until the end of the lease period.

Business leases are complex and, since the sums of money involved can be substantial, expert advice should always be obtained before reaching any agreement with a lessor about early settlement. Trading standards departments may be able to provide such advice.

VAT debts

VAT is a type of tax. Businesses with a turnover of an amount set each year by the government do not have to register for VAT, although they can choose to register voluntarily. All other businesses must register for VAT, unless HMRC grants an exemption from registering. VAT-registered businesses must file returns at a frequency agreed with HMRC to show the difference between the VAT they pay to other suppliers (input tax) and the VAT they charge their customers (output tax).

On 1 April 2019, most VAT-registered businesses needed to sign up to Making Tax Digital.1 These businesses must keep digital records and use HMRC-compatible software to produce and submit their VAT returns. From 1 April 2022, all VAT-registered businesses must sign up for Making Tax Digital unless they have an exemption from doing so. Exemptions are based on:

•your age; or

•a disability; or

•you running your business from a remote geographical location; or

•you objecting to using computers on religious grounds; or

•any other reason why it is not reasonable or practical.

If a VAT return or payment is late, HMRC may be able to add a surcharge. This can increase the amount owed. Changes were made to these rules from January 2023. This is a complex area. If a client disputes any surcharges or penalties that HMRC has applied, signpost them to specialist advice. Also, if the VAT return is outstanding, HMRC can estimate the amount due and issue its own assessment. The amount estimated by HMRC is payable immediately.

Local HMRC officers who collect VAT vary greatly in their approach to struggling or failed businesses. In general, they consider themselves to be collectors of a tax that has already been paid by a third party to the client and of which the client is only a custodian. While this may bear little relation to the realities of running a small business, this attitude means officers can be more aggressive in the recovery of VAT.

Once payment is outstanding, the HMRC officer at a local office usually uses the threat of enforcement action to take control of goods to force payment. This may initially consist of a visit, phone call or letter to state that enforcement action will be used. An enforcement notice giving seven clear days before action will then warn that immediate payment is required and enforcement agents will be used in default. A warrant to take control of goods is then signed by an HMRC officer. A court order is not needed.

The warrant is usually used by a firm of private enforcement agents with an HMRC officer in attendance. HMRC can obtain a warrant to force initial entry, but this is rare. However, most business premises are accessible to the public (including enforcement agents), so negotiation is essential. A client who is still trading should always try to give the enforcement agents some money and treat this debt with utmost priority. Taking control of goods can provoke or escalate the collapse of a business, both by removing necessary stock or equipment and reducing confidence in the business.

If you have a client with unpaid VAT, you should:

•contact HMRC, explain the position and request a short time to organise the client’s affairs; and

•get an accountant to check the amount claimed, particularly if it is an assessed amount; and

•explain the seriousness to the client. Use a small business adviser if necessary to look at the viability of the business and its credit control procedures.

HMRC can use other methods to collect the debt, such as court action, including the summary warrant procedure, to recover arrears of VAT.

HMRC also uses bankruptcy as a means of collection. Any threat of bankruptcy must be taken seriously.

More information can be from a qualified accountant or the HMRC guidance manual.2

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Income tax debts

Self-employed people and businesses are responsible for making a return to HMRC on which tax bills are based. Under the self-assessment system, taxpayers calculate their own tax and make a payment for each relevant tax year. A small business should always get specialist help in claiming all the allowances against tax to which it may be entitled, and in treating its profits and losses in the most tax-efficient way.

In addition to the tax due on its profits, a business may also owe tax and NI contributions on wages paid to employees.

The assessment process is outside the scope of this Handbook. If necessary, you should get specialist help to check the amount of tax demanded. TaxAid is a useful source of help or the Low Incomes Tax Reform Group.1

If the client fails to file a tax return, HMRC makes its own ’determination’ of how much tax is due and this can be enforceable immediately. It can only be overturned by filing a return and time limits apply. HMRC can impose penalties for late filing of returns and/or non-payment of tax. If there is no tax to pay when the return is filed, the penalty is not reduced and is, therefore, still payable by the client. They can appeal the penalty on the grounds that they had a ’reasonable excuse’ for the failure. It is still important to file returns, however late, because HMRC has a policy that payment arrangements are not accepted until returns are up to date.

What may count as a reasonable excuse?

A ‘reasonable excuse’ is something that stopped you from meeting a tax obligation that you took reasonable care to meet. Examples include the following.

– Your partner or another close relative died shortly before the tax return or payment deadline.

– You had an unexpected stay in hospital that prevented you from dealing with your tax affairs.

– You had a serious or life-threatening illness

– Your computer or software failed just before or while you were preparing your online return.

– Service issues with HMRC’s online services.2

– A fire, flood or theft prevented you from completing your tax return.

– Postal delays that you could not have predicted.

– Delays related to a disability or mental illness you have.

– You were unaware of or misunderstood your legal obligation.

– You relied on someone else to send your return, and they did not.3

You must send your return or payment as soon as possible after your reasonable excuse is resolved.

What does not count as a reasonable excuse?

The following will not be accepted as a reasonable excuse.

– Your cheque bounced or payment failed because you did not have enough money.

– You found the HMRC online system too difficult to use.

– You did not get a reminder from HMRC.

– You made a mistake on your tax return.

If a tax bill is unpaid, HMRC may be able to use the following types of enforcement:

•a debt collection agency or sheriff officer;

•petition for the client’s bankruptcy or put the business into administration or liquidation.

HMRC also has the power to use the summary warrant procedure, and subsequent diligence measures, speeding up the recovery process.

As with VAT, HMRC is likely to be particularly strict if the money owed includes tax already collected by a business from employees and not passed on to HMRC. HMRC will still consider starting bankruptcy proceedings, even if this is unlikely to lead to a payment being made. Any threat of bankruptcy must be taken seriously. They will first have to make the client apparently insolvent through a charge for payment or statutory demand.

If the sheriff court process is used, the client can ask for time to pay in the usual way. This is not available when the summary warrant procedure is used for business (company) debts.

It is possible to negotiate a time to pay arrangement with HMRC. Although it is generally easier to negotiate after the client has ceased trading, as with all negotiations, the outcome depends on the client’s circumstances. HMRC’s guidance How to Pay a Debt to HMRC with a Time to Pay Arrangement is available at . It explains the process and the information a client usually needs to provide to HMRC.

A client may also be able to set up an online time to pay arrangement for their self-assessment tax bill through their Government Gateway account without speaking to HMRC. To do this, a client must have filed their latest tax return and be within 60 days of the payment deadline. The client must also owe less than £30,000 and plan to pay their debt off within the next 12 months or fewer.

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