When Can Directors Be Personally Liable for Unpaid Corporation Tax?

Many directors assume that operating through a limited company means they are fully protected from personal liability. In most cases, this is true because a limited company is treated as a separate legal entity, and limited liability protects directors from being personally responsible for company debts.

However, this protection is not absolute. In certain situations, particularly where misconduct, negligence, or insolvency is involved, HMRC or a liquidator may seek to hold directors personally responsible for unpaid corporation tax.

Below are the key scenarios where directors may face personal liability.

Limited Liability and Corporation Tax

Under normal circumstances, corporation tax is the responsibility of the company, not the director. If the company is unable to pay its tax bill, HMRC generally pursues the company itself rather than the individuals managing it.

However, problems can arise if directors:

• Prioritise personal payments over tax obligations

• Pay connected creditors (such as family members or friends) while leaving tax unpaid

• Fail to act responsibly when the company is struggling financially

In such situations, HMRC may interpret the actions as misconduct or deliberate avoidance, increasing the risk of directors being personally pursued for unpaid tax.

This risk often becomes more significant during company liquidation, especially because HMRC is treated as a preferential creditor in many insolvency cases.

Fraudulent Trading

Directors can become personally liable if they are involved in fraudulent trading.

Fraudulent trading occurs when a company continues to operate with the intent to deceive creditors or carry out business for fraudulent purposes.

If a court determines that fraudulent trading has taken place, directors may be ordered to personally contribute to the company’s assets, which could include amounts related to unpaid corporation tax.

Wrongful Trading

Another potential risk arises through wrongful trading, which has a lower legal threshold than fraud.

Wrongful trading occurs when directors continue operating the company even though they knew or reasonably should have known that insolvency was unavoidable.

If the company’s corporation tax liability increases during the period of wrongful trading, a liquidator may apply to the court to recover funds from the directors personally.

Although the claim is usually initiated by the liquidator rather than HMRC, unpaid corporation tax often forms a significant part of the overall liability.

Unlawful Dividend Payments

Directors and shareholders can also face personal exposure if dividends are paid unlawfully.

Under the Companies Act 2006, dividends can only be paid from distributable profits, which are defined as:

• Accumulated realised profits

• Minus accumulated realised losses

This means:

• Dividends can still be paid during a loss-making year if sufficient retained profits exist.

• Dividends cannot be paid if previous losses exceed current profits.

If a director authorises a dividend when sufficient reserves are not available, and they knew or should have known the payment was unlawful, the dividend may need to be repaid to the company.

This situation can occur even when directors did not realise at the time that the company accounts did not support the dividend payment.

During liquidation, a liquidator may attempt to recover dividends if the payment contributed to insolvency while corporation tax remained unpaid.

In owner-managed businesses, where directors and shareholders are often the same individuals, the financial exposure can be particularly significant.

Capital Distributions After Asset Sales

Another situation where personal liability may arise involves capital distributions following asset disposals.

A capital distribution refers to a payment made to shareholders that is treated as capital rather than income for tax purposes.

If a company sells assets and generates chargeable gains, corporation tax becomes payable on those gains.

Problems can occur if:

1. The company distributes funds to shareholders, and

2. The related corporation tax is not paid within six months of the due date.

In such cases, HMRC has the authority to pursue the shareholder who received the distribution. An assessment can be issued within two years of the corporation tax due date.

Key Considerations for Directors

To reduce the risk of personal liability, directors should ensure they:

• Prioritise paying corporation tax when it becomes due

• Only declare dividends from distributable profits

• Monitor the company’s solvency before making payments or distributions

• Avoid paying connected parties ahead of HMRC when the company is struggling financially

Maintaining proper financial oversight and seeking professional advice can help directors avoid situations where personal liability may arise.

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