Bankruptcy and tax debt

Introduction

Bankruptcy is a way in which the law may deal with a person who is unable to pay their debts.

Following an order of bankruptcy, a Trustee is appointed who gathers in your assets towards payment of your debts fairly between your creditors, according to certain rules. Bankruptcy also imposes a number of restrictions on what you can do.

Broadly, if you are made bankrupt:

• You stand to lose any valuable assets that you own at the time of the bankruptcy order, including your interest in your home, your business assets, bank accounts, savings and investments, and certain pension rights, towards payment of your debts.
• During the period until you are discharged , which normally happens automatically after one year, you may be ordered to make payments from your income, or any other money you receive, towards payment of your debts.
• Also, until you are discharged, you may not hold certain positions such as being a company director, or seek to borrow over £500 without disclosing that you are a bankrupt.
• Your bankruptcy will be published in the London Gazette and in a national and/or local newspaper. So some people will become aware that you have been made bankrupt which may be embarrassing. The bankruptcy will be noted by the credit reference agencies, making it difficult for you to borrow money for about six years after you have been discharged.

On the other hand, bankruptcy does offer certain 'advantages':

• Once you are made bankrupt, you are no longer personally responsible for sorting out your debts. Your creditors must deal with your Trustee, which removes one enormous pressure of being in debt.
• When you are discharged, most debts that you owed at the date of the bankruptcy which have not been settled by your Trustee are written off.

So if you are hopelessly in debt and have no valuable assets to lose, bankruptcy may offer welcome relief from a desperate situation and the chance of a fresh start.

What happens when your file reaches the Enforcement Office

When your file reaches the Enforcement Office, it will write to ask you to pay the full debt quickly (normally within 14 days) or to make a proposal for payment. It will sometimes accept an arrangement for the tax to be paid within a matter of months, but will not usually consider any offer that will take over a year to clear the debt.

If you are not able to pay the tax or agree a payment arrangement, or if you fail to stick to a payment arrangement, the Enforcement Office will usually write to say that it is starting bankruptcy proceedings.

It is important to understand that the Enforcement Office does not behave like most commercial creditors. In particular, it often petitions for bankruptcy even where it is clear that this will not benefit the Revenue because the taxpayer has no assets. Indeed, sometimes the bankruptcy costs the government money, because the bankrupt loses their home and/or job and is forced to rely upon council housing and/or welfare benefits.

Very occasionally the Enforcement Office may decide not to take further action against a person who is unable to pay. This might apply where you have no assets and a low income, and your situation is unlikely to change in the future because you are older or suffering from long-term poor health. The debt is never written off completely, and bankruptcy action could be taken if your circumstances improved at a later date.

The Statutory Demand

The first stage in the legal process is the service (i.e. delivery to you) of a statutory demand , which is a formal document stating the amount owed to the Revenue. Normally this will be delivered to you by hand.

By law you may apply to have a statutory demand from any creditor 'set aside', for example because the amount demanded is not due, but in tax cases such an application is unlikely to be successful. This is because section 70 of the Taxes Management Act 1970 says that the certificates that will be produced by the Revenue, stating that tax has been charged and has not been paid, must be accepted by the court as sufficient evidence that the tax is due.

The bankruptcy petition

After three weeks have passed following the service of a Statutory Demand, the Revenue may proceed to present a bankruptcy petition . The petition is filed at the High Court in London , and is then served on you personally. If you try to keep out of the way, so as to avoid receiving the petition, the court may order service in another way, for example by post or advertisement.

The petition gives details of the tax due and tells you the date and time when the case will be heard at the Bankruptcy Court. This must be at least ten work ing days after the petition is served on you.

The bankruptcy hearing

Inland Revenue petitions are heard in private before a Bankruptcy Registrar at the High Court in London . The procedure is not formal. You may represent yourself, or ask a lawyer, accountant, other adviser or even a friend or relative to present your case for you.

There is a process for opposing a bankruptcy petition but, as with a statutory demand, there will not often be good grounds in a tax case.

More often, you may want to ask the court for an adjournment, to allow time to: raise the money, or

• reach a payment arrangement with the Revenue, or
• contest the amount demanded, or
• make a complaint if you believe that this might lead the Revenue to withdraw its demand.

The court may well be prepared to grant an adjournment for two months or so.

If during the period of the adjournment (or further adjournment(s) if granted) you are successful in raising the money necessary to clear the tax, reaching an agreement with the Revenue or getting the tax demand withdrawn, then the Revenue will apply to have the petition dismissed, which is the end of the matter.

If you are not successful, the Revenue will ask the court to make an order for your bankruptcy, to which the court is likely to agree.

After the bankruptcy order is given

Soon after the order has been given you will be told to attend an interview with the Official Receiver , who work s within the Insolvency Service of the Department of Trade and Industry. You will be sent a questionnaire on which to give full details of your financial affairs, and will be asked to hand over your financial records, such as bank and building society passbooks and statements, company shares and life insurance policies.

One of the Official Receiver's duties is to arrange for the appointment of a Trustee , who will administer your affairs during your bankruptcy. If you have valuable assets or a high income, he may appoint an authorised insolvency practitioner (who is often an accountant) as your Trustee; otherwise the Official Receiver may act as your Trustee instead.

The Trustee's job is to supervise your affairs during your bankruptcy. He will seek to raise funds from your assets and distribute these to your creditors. He may obtain an order or enter into an agreement with you to pay part of your income to him for a period of up to 3 years , if this is more than is reasonably needed for your living expenses. If you enjoy a sudden rise in income or receive a capital sum (for example money left to you in a will), you must report this to him and he may claim it too. He will also consider whether you have committed any offences in relation to the bankruptcy, or your conduct before or after the bankruptcy order constitutes grounds for a Bankruptcy Restrictions Order to be made against you.

If you have enough assets to pay off all your creditors in full, and the costs and fees of bankruptcy, anything left will be returned to you and the bankruptcy order annulled.

Costs and fees

The administration of a bankruptcy is expensive, and the costs and fees of bankruptcy must be met from the sums raised by your Trustee before the payment of your creditors.

e.g. Tom is made bankrupt owing £50,000 to all his creditors, and having assets which are sold for £25,000. Depending on the circumstances of the case, the costs of bankruptcy might be £8,000, leaving £17,000 to be shared between the creditors.

In the above example, the costs do not affect Tom directly; they simply reduce the amount that is available to his creditors, increasing the amount that they lose because of his bankruptcy.

However, if your assets are worth more than your debts, the situation is different.

e.g. Teresa is made bankrupt owing £50,000 to her creditors and a house which is eventually sold for £60,000 (after payment of the outstanding mortgage). The costs of bankruptcy may be more than £10,000, leaving nothing to be paid to Teresa.

If Teresa had sold her house before bankruptcy and paid off her creditors, she could have avoided these costs. So if you think that your assets are worth more than your debts, you should do everything you reasonably can to avoid a bankruptcy order being made, as the costs of bankruptcy can be penal .

What happens at the end

In most cases you are discharged from bankruptcy automatically after one year. You are then freed from the restrictions described above. You are also released from the debts that you owed at the time of the bankruptcy order, apart from certain debts such as fines, student loans and unpaid maintenance.

Discharge is automatic even if you have been made bankrupt more than once. However if you have been bankrupt at any time in the previous 6 years the court may take this into account in considering an application for a Bankruptcy Restrictions Order against you. In such cases, you must ask the court for a discharge and cannot do so until five years after the order has been given.

Transitional provisions are in place for existing first time bankrupts as at 1 April 2004 when reforms of the bankruptcy system came into force. They will be discharged on the earlier of the normal two/three year anniversary of the order or one year from commencement on 1 April, whichever is the earlier. Existing second-time bankrupts (where both orders were made before commencement) are discharged either 5 years from commenced or by application if eligible earlier.

Individual voluntary arrangements

Bankruptcy can sometimes be avoided by entering an individual voluntary arrangement ('IVA') with your creditors. This can be any arrangement to pay them part or all of your debts, immediately or over a period of time, provided it is acceptable to over 75% of your creditors (by value of the amounts owed).

An IVA may be attractive to your creditors because, for example:

• It may allow you to continue to run a business, offering the possibility that you may raise more money to pay your debts.
• It may be cheaper in terms of costs, leaving more money for creditors.

An IVA may be good for you, as it avoids the restrictions and costs of bankruptcy, and you may reach an agreement which allows you to keep assets that would have been sold in a bankruptcy.

Unfortunately, many people facing tax debts are unable to make an IVA because:

• they are unable to raise the fees necessary to pay an insolvency practitioner who is required to supervise the IVA, or
• creditors who are owed 25% of your total debt vote to block your proposals.

Nevertheless, it is worth exploring whether you might be able to propose an IVA which might be acceptable to at least 75% of your creditors. Most insolvency practitioners will be happy to have a short meeting with you - without making any charge - to consider whether this is possible. However, we would warn that it can be difficult to obtain the Revenue's agreement to an IVA, if it is owed more than 25% of your debts.

Making yourself bankrupt

If your situation is so hopeless that:

• it is clear that you will eventually be made bankrupt by one of your creditors, or
• your debts are a constant cause of worry and the situation will not improve,

then you might consider making yourself bankrupt.

This can be done by visiting the High Court in London , or your nearest County Court if you live outside London , and the court staff will usually be prepared to help you with the forms. You will need to take money to cover the £310 deposit, and possibly a further £140 towards court fees.

The possible advantages of a debtor's bankruptcy are that:

• You gain some control over your situation, rather than leaving the decision as to whether and when you are made bankrupt to your creditors.
• You can speed up the date on which you are made bankrupt, so as to be discharged as early as possible.

Bankruptcy and your home

Your home is an asset which is at risk if you are made bankrupt.

If you rent the property, there may be a clause which allows your landlord to end the lease if you are made bankrupt. However, if you live in a council or housing association property, then it is unlikely that you will lose your home.

If you own your home (alone or jointly), and it is worth more than the amount owed on any mortgage(s) and other loan(s) charged on it, then there is equity in the property and your Trustee will probably want it sold so that the equity can be used to pay your creditors. If your wife, husband or children are living with you, then you are usually given 12 months before any sale can take place. This is to give you time to make other living arrangements, and to see whether a relative or friend might be able to buy your interest in the property from the Trustee, which avoids a sale.

If there is no equity in the property, because its value is lower than the loan(s) charged on it, then your Trustee may obtain a charging order on the property. You are allowed to remain living there, but the Trustee then has an interest in the property which will be restricted to the value of the equity at the time of the charging order plus statutory interest until it is realised. There is no time limit for realization but the benefit of any rise in property values will not accrue in full because of the restriction. There will therefore be little incentive for a trustee to delay realization until years afterwards as was previously the case under the old rules. However any uncertainty can often be avoided by arranging for a relative or friend to buy your interest in the property for a small amount, soon after the bankruptcy order. Generally trustees now have to deal with interests in property within 3 years or that interest will revert to the bankrupt. This and the other matters referred to above are explained more fully in the Insolvency Service leaflet What will happen to my home .

Bankruptcy and your work

After bankruptcy, most employees may continue in the same job as before, and quite often their employer will not even be aware that they have been made bankrupt. However, in certain jobs it is a condition of your contract that your employer is informed, and your contract may be terminated. And you cannot continue work ing as a company director.

If you are self-employed , work ing on your own, you may be able to continue as before, for example if you are a mini-cab driver, actor or construction work er. You will usually be allowed to keep the necessary tools of your trade. However, in certain professions such as accountancy or estate agency, you may be prohibited by your professional body from continuing to practice while bankrupt.

If you run a business employing staff, owning valuable trading stock or relying substantially on trade credit, this will probably be closed down or sold by your Trustee.

Tax after bankruptcy

As a general rule, the tax due for all tax years up to and including the tax year in which you are made bankrupt will be due from your Trustee - from the money he is able to raise - and not from you personally.

So if you are employed and paying tax under Pay As You Earn (PAYE), you should ask your tax office to put you onto a 'Nil' tax code immediately after the bankruptcy order. You should then be paid without income tax taken off for the remainder of the tax year. If for any reason this does not happen, and some tax is deducted after bankruptcy, this should be refunded to you by the Revenue. However, if you move to a different employer, this rule ceases to apply and tax should be deducted on an 'emergency' basis.

If you are self-employed, your duty to pay tax directly to the Revenue will no longer apply to the tax year of bankruptcy or any previous year. You start paying tax directly from the following tax year.

One exception to the last rule affects self-employed work ers in the construction industry, who have tax taken off their earnings at a flat rate of 18%. This deduction continues after bankruptcy, and the amounts that are deducted between your bankruptcy order and the following 5 April are paid by the Revenue to your Trustee.

Further information and advice

Bankruptcy is a complex matter and more information is given in a Guide to Bankruptcy published by the Insolvency Service of the Department of Trade and Industry. Copies are also available by phoning Insolvency Service Publications: 01254 682702 and on their website at www.insolvency.gov.uk.

If you want personal advice and can afford to pay for this, you might seek help from an authorised insolvency practitioner and a list should be available from your local court or Official Receiver's office.

If you need confidential and non-judgemental advice on legal procedures or practical aspects of bankruptcy, you might contact the Royal Courts of Justice Advice Bureau at Principal Registry of the Family Division, Fourth Floor, First Avenue House, 42-49 High Holborn, Strand, London WC1V 6NP. You may visit without an appointment, any work ing day between 10am - 1pm , or 2pm - 5pm . Or you may telephone 020 7947 7604, any work ing day between 11 - 12am or 3 - 4pm.