Annulling a Bankruptcy Order Founded on an HMRC Tax Debt

Annulment removes the bankruptcy; discharge removes the debts. Clients almost always want the first and are usually advised about the second. This guide sets out the two statutory grounds under s282 Insolvency Act 1986, the IVA route under s261, the procedure and evidence, and why the insolvency court will rarely examine whether the tax was actually due.

Introduction: Annulment Is Not Discharge

HMRC is one of the most prolific petitioning creditors in the bankruptcy courts. Where a taxpayer has been made bankrupt on an HMRC petition (often on an assessment the taxpayer disputes, or after a statutory demand that was never properly served) the question is almost always the same: can the bankruptcy be undone?

It can, but the mechanism is frequently misunderstood. Three quite different remedies are routinely confused:

The Two Statutory Grounds Under s282(1)

s282(1)(a): the order ought not to have been made

The court may annul where it appears that, on any grounds existing at the time the order was made, the order ought not to have been made. This is a retrospective review of the validity of the order on the material as it stood at the time. Typical grounds in an HMRC case include:

• The petition debt was not for a liquidated sum due at the time, or was disputed on substantial grounds.
• Defective service of the statutory demand or the petition, or service at an address the creditor knew to be wrong.
• An outstanding appeal. Where a valid appeal against the underlying assessment was pending and tax had been postponed, the debt may not have been due and payable.
• The debt had been paid, secured or compounded before the order was made.
• The debtor was able to pay all their debts at the relevant time.
• Procedural irregularity in the petition, the hearing or the evidence before the court.

s282(1)(b): the debts and expenses have been paid or secured

The court may annul where it appears that, to the extent required by the rules, the bankruptcy debts and the expenses of the bankruptcy have all, since the making of the order, been either paid or secured for to the satisfaction of the court.

This is the practical route in the majority of cases, because it does not require the applicant to prove that the order was wrong. It requires money. Three features are commonly missed:

• “Bankruptcy debts” means proved and provable debts, and does not include post-bankruptcy statutory interest. Interest accruing after the date of the order is not part of the sum that must be paid for these purposes, though the trustee will want it addressed if there is a surplus.
• “Expenses of the bankruptcy” is a large and often underestimated figure: the Official Receiver’s fees and general fee, the trustee’s remuneration and disbursements, and the costs of the petitioning creditor. These must be paid or secured before the court will annul, and they are frequently a multiple of what the client expects.
• “Secured to the satisfaction of the court” is a real alternative to payment: payment into court, a solicitor’s undertaking, a charge over property or a bond may suffice. This matters where the client’s only asset is the family home and a sale would take months.

s261: annulment following an individual voluntary arrangement

A third route exists where a bankrupt proposes and obtains approval of an IVA after the bankruptcy order. Under s261 the court may annul the bankruptcy order on the application of the bankrupt or the Official Receiver. This is distinct from s282 in an important respect: because the debts are dealt with within the arrangement, the debtor is not left liable for the full amount in the way that a s282 annulment leaves them.

Procedure and Evidence

The application is made to the court that made the bankruptcy order, supported by a witness statement. The Insolvency (England and Wales) Rules 2016 govern the process.

What the application must specify

The application must state which ground is relied on (s282(1)(a), s282(1)(b), or s261), and the supporting witness statement must set out the grounds in full. Where the ground is payment or securing of debts and expenses, the statement must give particulars of the creditors and the amounts, and explain the source of the funds.

The office-holder’s report

The Official Receiver or trustee must file a report with the court in advance of the hearing, dealing with the circumstances leading to the bankruptcy, the extent to which the bankruptcy debts and expenses have been paid or secured, and any other matters the court ought to know. In practice this report drives the outcome. An application filed without first engaging with the trustee on the figures will be adjourned, at the applicant’s cost.

Source of funds

Third-party funds are perfectly acceptable, and are the norm: family, a refinance, or a purchaser of the debtor’s property. The court and the trustee will want to understand where the money has come from, particularly where the bankruptcy arose out of an HMRC investigation into undeclared income. Advisers should anticipate that question and answer it in the evidence rather than at the hearing.

Delay

There is no statutory time limit for an annulment application. Delay is nonetheless a significant discretionary factor, particularly under s282(1)(a): the longer the bankruptcy has run, the more third parties have acted on it, the more the trustee has done, and the harder it becomes to unwind. An application made shortly after the order stands a materially better prospect than the same application made three years later.

The HMRC Dimension: Going Behind a Tax Debt

The most common instinct of a taxpayer facing an HMRC bankruptcy is to ask the insolvency court to examine whether the tax is really due. That instinct usually fails, and understanding why is essential to advising properly.

The correct sequence

1. Deal with the tax in the tax forum. If the assessment is out of time to appeal, apply for permission to make a late appeal, to HMRC under s49 TMA 1970 for direct taxes, or to the tribunal, applying the three-stage test in Martland v HMRC [2018] UKUT 178 (TCC).
2. Apply to postpone the tax under s55 TMA 1970 where an appeal is live, so that the sum is not due and payable.
3. Then use the resulting position to support a s282(1)(a) application, or to reduce the sum that must be paid under s282(1)(b).

Where the bankruptcy has already been made, an alternative and often faster route is to negotiate a Time to Pay arrangement or a post-bankruptcy IVA and annul under s261.

The statutory demand stage

Prevention is far cheaper than annulment. A statutory demand founded on a tax debt can be set aside under rule 10.5 of the Insolvency (England and Wales) Rules 2016 where the debt is disputed on substantial grounds, where the debtor has a counterclaim, set-off or cross-demand equalling or exceeding the debt, or where the demand is otherwise defective. The application must be made within 18 days of service. That window is short and is missed constantly.

The Effect of an Annulment

• The order is treated as never having been made. But s282(4) preserves the validity of things properly done by the Official Receiver or the trustee in the interim, sales of assets to third parties are not undone.
• Property revests in the debtor, subject to any disposals already made and to any directions the court gives.
• The debts survive. Under s282 the debtor remains liable for any bankruptcy debt not actually paid. This is the point clients most often misunderstand. An annulment obtained under s282(1)(a) on procedural grounds leaves HMRC free to pursue the tax.
• The register entry can be removed. On annulment the entry may be deleted from the Individual Insolvency Register, which is frequently the client’s real objective, particularly where they hold a regulated position, a directorship, or professional membership.
• Restrictions. A bankruptcy restrictions order or undertaking is a separate matter from the bankruptcy order itself and needs to be addressed separately; it does not necessarily fall away simply because the bankruptcy has been annulled.

Practitioner Application

Deciding whether to apply

• Identify the client’s actual objective. Removal from the register and restoration of professional standing points to annulment. Relief from debt points to discharge or an IVA. The two are not interchangeable and the costs are very different.
• Cost the expenses first. Obtain the trustee’s and Official Receiver’s figures in writing before advising on feasibility. An application under s282(1)(b) that founders on unbudgeted expenses is worse than no application at all.
• Test the underlying tax debt in the tax forum. Reducing or extinguishing the assessment reduces the sum required and may found a s282(1)(a) application in its own right.
• Move quickly. Delay damages the discretion and increases the expenses, which compound as the trustee continues to act.
• Engage the trustee early. The office-holder’s report is the single most influential document at the hearing. It is far better to have the figures agreed than contested.

Where the client is a director

Bankruptcy disqualifies an individual from acting as a director. Where the client holds directorships, the practical urgency is much greater and the sequence should be planned around it, including whether to seek permission to act under s11 of the Company Directors Disqualification Act 1986 while the annulment application is pending.

Frequently Asked Questions