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Tax due on money stolen by (ex) Director?

Tax due on money stolen by (ex) Director?

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An ex-Director allegedly stole in the region of £100K from our company over a period or two years.

The company provided for a potential liability for PAYE and NI on the theft within it's year-end accounts. The auditors disclosed the provision to the Revenue who have now issued a demand for PAYE, employers and employees NI plus interest.

The company have reported the (alleged) theft to the police and may be able to bring legal action (but no guarantee of recovery). Does the Revenue have a valid case to made this claim or are they merely being opportunistic?
ANON

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By AnonymousUser
21st Jul 2003 18:13

Thank you
I should like to thank all contributors especially Nicki and Will for their advice.
Your comments will be passed onto the board for consideration.

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By Taxi
21st Jul 2003 11:10

Yes, I have to agree, I was mulling this over at the weekend,
and the theft (which is something for the criminal courts, and possible compensation under legal action as a criminal act) cannot be placed under S.19 for an Inspector's convenience.
I feel the treatment for tax will follow the treatment in the accounts (which may in this case need revising).
If there is a criminal prosecution involved and also a claim for compensation, then the stolen sum should sit in debtors, waiting the court outcome.
If there is no criminal prosecution, no further police involvement, then that may well indicate a different angle - does this indicate that the sums stolen have been sanctioned as remuneration? You will need proof on file that legal advice was sought and that the police declined to take action in the criminal courts, and that the company reviewed this with their solicitors and found that it was not financially viable to proceed a civil action.
Hopefully one can then argue that the theft is not within S.19.and this takes us on to the allowability in the accounts.
Against an allowable deduction in the accounts is the case law we have mentioned, all my text books and some other cases involving shadow directors. I really would not be easy fighting the theft as allowable, and so my feeling here is no way can you get around this problem by just saying "this was an employee whose title is director", because the fact was he was a person in accordance with whose directions or intructions the directors were accustomed to act, and he was a board dirctor- and that places him firmly within R. v. Allen, and Curtis and Bamford. Also note Roebuch Printing, where the MD "took" the sums, but they were sanctioned by other board members.
On S.419 I think you can argue that by saying "it is not a loan!", and if you have already argued the s.19 case, this bit should be a breeze!

Will, if you want to debate further privately my email is [email protected]

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By Anonymous
20th Jul 2003 06:59

COMMENT Part 2
I would say that there could well be a set of circumstances in which misappropriations by a director would be an allowable loss. There are also many cases where the Revenue would not even consider that misappropriations by a participating director should be taxable under Schedule E (let alone a minority shareholder or no shareholder at all). The inspector would normally go down the S419 route but would be entitled in given circumstances (such as the misappropriations by a controlling director) to come to an alternative conclusion that the defalcations were analogous to remuneration. Those circumstances may apply, for example, where the inspector sees no chance of getting a s 419 charge because the company has gone bust, but the director is still available (whether alive or even dead in certain circumstances) to attach a Schedule E liability to. Prejudging that event by providing for PAYE/NIC would seem to me to be folly except under certain conditions which may or may not apply in this case. There is not enough information to conclude that either way.

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By Anonymous
20th Jul 2003 07:00

COMMENT Part 1
Nicki, I am sorry but I do not agree with you on this one.

You said “am now totally satisfied that a non-participator- director/employee would be caught under S.19 -old Sch E …….. It should be run through the payroll as salary” and “Case law says this is not allowable against the company's profits, I think we agree on that one.” (both 18 July)

1 PAYE can only be applied to earned income taxable under Schedule E (leaving aside mongrel law such as IR35 and other matters that are specifically brought into Schedule E). At the time that an employee steals money (and the director in this case appears to be a full time working director who is not a participator or an associate of a participator) the “receipt” of that money could not have been an emolument caught by s 19 ICTA 1988 therefore it could not have PAYE/NIC applied to it subsequently. Theft is defined as dishonestly appropriating property belonging to someone else with the intention of permanently depriving them of it. It is not the subject of Schedule E.

2 On the other hand a loss to the business due to employee defalcation is “normally” allowable as a deduction but, according to IM 841 “for this purpose an employee must not be regarded as including a director”. IM 841 then quotes the cases of Curtis and Oldfield (9TC319) and Bamford (48TC359) as its authority for that statement. In the first case the company was wholly owned by the director and in the second case the director was a 50% shareholder. In both cases the loss involved a claim for the writing off of loans or debts due by the directors. The direction in the Inspectors’ Manual is disingenuous to say the least. It makes no distinction between someone who can control the business of the company such that the loss is a business loss and someone such as an employee whose title is “director” who does not have that power such that the loss would not be a loss that would be excluded under ICTA 1988 s74.

3 Hudson v Humbles (42TC380) concerned unexplained receipts in the director’s personal account but again he was a controlling director and this is one of those cases where it is clear that the inspector is entitled to take a view about a set of circumstances and it is for the appellant to disprove that view. The inspector considered that the receipts were undisclosed remuneration from the company and no evidence was given by the appellant to disprove that view. This hardly supports the apparent circumstances of the case outlined in this query.

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By Taxi
16th Jul 2003 16:04

Must be the time of year but i have two cases involving
theft on my desk to review right now... leading cases are Curtis v J & G Oldfield, Roebank Printing Co v. CIR and Bamford v ATA Advertising (Tolley's cases pg 490/491)- all which disallow a deduction from profts. Then, Stephen V. T Pittas which considered whether the misappropriations were losses or advances, and lastly, Khera's Emporium Ltd v. Marshall which decided that S.419 tax was at stake. If i were you I would go for the S.419 option - an illegal loan, hopefully recoverable.

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By Taxi
17th Jul 2003 09:55

true, but the exemptions in s.420 mean that a director who works
having no material interest in the share capital, would be caught under s.419, because of the size of the loan.
Going back to the Sch E charge, take a look at Enquiry Manual 8810. These cases concern back duty, and misappropriations of company reciepts by directors, and your inspector may well have these in mind.

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By Anonymous
16th Jul 2003 19:32

But ...

if the ex-director is not a participator, nor an associate of a participator then there can be no s419 liability

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By Anonymous
14th Jul 2003 21:20

Sounds like a staff fraud

The losses are therefore allowable for tax purposes.

The IR have no hope of getting any PAYE liability as there is no evidence that the funds were intended as pay.

Get some specialist advice, but look at the IM and EM on the IR website they should give you some clues

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By AnonymousUser
14th Jul 2003 14:54

Director
Hxj,

The director had no shareholding and the company's shareholders and other officers were not aware of the (alleged) theft at the time.

The Revenue are basing their claim on a letter written by the auditors to the Revenue supporting the accrual in the year-end accounts for losses that might be incurred as a result of the (alleged) theft.

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By Anonymous
14th Jul 2003 13:35

POTENTIAL S 419 POSITION
In the circumstances that you describe I am not sure why the accountant provided for PAYE/NIC rather than debiting the director's loan account.

Is this a close company?

Is the director a full time working director with no shareholding and no connection (as defined by tax law) with the other directors or is he a participator by virtue of shareholding etc?

If the former then this loss may be capable of tax allowance without PAYE/NIC depending on the circumstances. For example see the tax case of Gray v Lord Penryn 21 TC 252 in which compensation for money defrauded by workers was held to be taxable (because the loss was allowable).

If the latter then I would have expected the loan account to be debited but then a claim from the Revenue for tax under s419 as a "deemed distribution". The company is assessed to tax effectively at the basic rate for individuals but this tax is then repaid if and when the director restores the money to the company.

This sounds draconian particularly as the Revenue will do this even if the director is not a majority shareholder. I have known this happen several times (in one case where a 25% shareholder finance director took over £200,000 because the other directors let him have blank signed cheques!!!!). There are arguments against this standpoint but they have not been tested before the Commissioners as far as I am aware.

Having provided for PAYE/NIC the Revenue have only followed the logic of situation as presented to them presumably without considering any alternatives.

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By Taxi
18th Jul 2003 10:21

I was just observing (slightly sardonically, although you would
realised, without any punctuation to create expression), that the exemption from S.419 really makes not sense at all if you apply it to directors who are not participators, because it refers to directors "without a material interest in the company", and that could mean that they are not shareholders as all... I won't go on, but hope you get my drift.
Been sadly reading more on this, and am now totally satisfied that a non-participator- director/employee would be caught under S.19 -old Sch E (sorry not up to date enough to know if there is a new ITAPA ref.) It should be run through the payroll as salary.
A participator-director stands in a slightly different light, and hence all the case law below. S.419 is very likely. As the participator would be taxed on a distribution the amount stolen would then be grossed up by 100/90.

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By Anonymous
12th Jul 2003 19:57

Sorry some questions first

Was the director a shareholder?

If not does anyone suspect that the shareholders were aware of the position?

What reasons have the IR given for the, presumably, Reg 49 Determination?

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By Anonymous
14th Jul 2003 17:15

NEEDS A SERIOUS REVIEW
As stated in my previous contribution - if the director is basically a full time worker with an enhanced status but is not connected with other director/shareholders then there is reasonable chance that the loss can be argued as tax allowable withoput accounting for PAYE/NIC.

Clearly one would need more detailed facts but an alleged fraud on a company if that is what it is cannot be taxed as income under Schedule E (for those of us not yet familiar with ITEPA)so am not sure of the accountant's logic here.

This is a large amount of money. It is worth getting an opinion from a relevant tax specialist.

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By specialtax
18th Jul 2003 11:22

MORE INFO PLEASE
Sorry Nicki I do not understand why you consider an unauthorised extraction of money from a company as taxable under s 19 ICTA 1988 - Schedule E (forget about ITEPA for the time being – I’m also still trying to get to grips with that). Please explain. (Incidentally I accept that there are tax cases which show that the Revenue can have alternative views on the same facts and so can assume that money has come from a source that is taxable under Schedule E but that is not the same point)

As regards s 419 this cannot operate unless a “loan” has been made to a participator or an associate of a participator in the right circumstances. As HXJ says – s 420 is not relevant unless there is a potential charge under s 419.

The only reason that S 419 appears (and I stress “appears”) to operate in the case of a director who is a participator or an associate of a participator is through the case law noted by Nicki – which you will find is concerned with directors all of whom either controlled the company that they took the money from or were in control by ascribing the share ownership of their associates.

The Revenue will also insist that money stolen by a non-controller participator is also subject to s 419. This turns on the definition of a “loan” for the purposes of s 419. I will not go into the detail here partly because I disagree with the Revenue interpretation and would welcome the chance of arguing it with them in a suitable case.

I nearly had a chance with one of the cases that I dealt with concerned a 25% shareholder director who was not associated with the other directors. He was a qualified practising accountant who embezzled money from a company of which he was also financial director by the simple expedient of vastly overcharging (among other items) for his professional services using blank cheques that the other directors had pre-signed. Unfortunately the company concerned decided that they did not want to pursue the matter to the Commissioners so the Revenue’s case was conceded.

If the originator of this Any Answers query or anyone reading this has a similar problem I would be interested to be sent some details via [email protected].

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By Anonymous
18th Jul 2003 15:50

Ok, my thinking is as follows:
1. The money is not a loan, not a distribution, but funds acquired by virtue of the fact that he was in charge of the chequebook.
2. Case law says this is not allowable against the company's profits, I think we agree on that one.
3. Close company case law tends to assess directors who misappropiate company funds under sch E, and the Revenue somewhat select listing of cases in EM8810 further backs their view. The case of Hudson V Humbles is, in my opinion quite a strong one. After all if he has not misappropriated company funds then there can be no theft.
4. The alternative view is that it is not remuneration, but an illegal distribution and hence requires grossing up, in the hands of the receipent, and s.419 comes into play, but to be honest i find this difficult if the director is not a participator, and I am sure that the Mem and Arts would not allow ditributions legal or not to non-shareholders.

The best outcome would be that it was covered by insurance, the sum could then become a debtor until re-imbursed, and I suppose in this case the auditors found this not to be the case and so w/o to P & L.

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By Anonymous
17th Jul 2003 17:26

Sorry don't follow

The legislation that you are talking about exemptions loans that would otherwise be caught under ection 419 from the charge.

Such a relieving rule cannot operate to bring in a charge to tax

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