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HMRC internal manual

Enquiry Manual

Close Companies: Settlement: Company or Directors

When the facts relating to the evaded profits have been established, you must decide the correct tax consequences resulting from the evasion.

If the evasion is of a non-extractive kind, settlement is with the company as this is the only person to have gained. Non-extractive irregularities are understatements of profits or claims for excess relief that do not involve money or value being diverted from or taken out of the company. The tax bill is lower or deferred, which increases the worth of the company.

Extractive irregularities are money or value diverted from or taken out of a company by, or at the behest of, the directors or participators. The company’s worth is diminished because it has lost funds. If the evasion has been extractive, decided tax cases support either settlement with the company, as omitted profits liable to Corporation Tax (and any consequent liability under CTA10/S455), or with its directors as undisclosed employment income from the company, paid out of the evaded profits. The basis of settlement depends on the particular facts and circumstances of each case.

In the normal case there will be no evidence that an unexplained source of money or a capital reconciliation deficiency is anything other than a misappropriation of company funds by a director or participator. Curtis v J & G Oldfield Ltd (9TC319) provides general authority for their taxation as company profits. The Tax Cases EM8800+ decided subsequently have been, in many cases, about the source of the money required to explain a capital reconciliation deficiency, rather than whether extractions should be assessable on the company (with CTA10/S455 consequences) or on the individual directors personally as employment income. These cases have involved both approaches to settlement, showing that either route is possible.

The facts of a case are important in deciding the correct approach. As soon as extractions, either by diversion of company receipts or by false description or inflation of expenses in the company accounts, are established all the evidence should be considered to decide what those extractions represent. This will include whatever documentary evidence is available and the oral evidence of the director(s) who should be asked to explain how the extractions took place and what they and the company believe the extractions represent.

In the absence of good evidence, such as amounts being taken on a regular basis (particularly weekly or monthly) that might suggest employment income, do not commit to a particular treatment. Instead follow the guidance at EM8605.