England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
COMPANIES COURT

		Royal Courts of Justice Strand, London
		24th June 2008

INDEX

	Para
A. Introduction	1-3
B. Representation	4-5
C. Witnesses	6-14
D. Corporate Structure	15-26
E. Corporation Tax Difficulties	27-35
F. Outline of Allegations	36-38
G. The Principal Issues	39-40
H. Factual Background	41-163
(i) 1998	41
(ii) 1999	42
(iii) 2000	54
(iv) 2001	55
(v) 2002	70
(vi) 2003	80
(vii) 2004	92
I. Were Mr and/or Mrs Holland "de facto" Directors of the Composite Companies?	164-189
(i) Introduction	164
(ii) General Principles	169
(iii) Corporate Veil Point	170
(iv) Mrs Holland	180
J. Lawfulness of Dividends - Liability of Directors	190-218
(i) Statutory Provisions	190
(ii) Rival Contentions	191
(iii) Preliminary Observations	193
(iv) Provision for Liabilities "likely to be incurred"	196
(v) Strict Liability?	200
(vi) Remedy	213
K. Section 727 CA 1985	220-226
L. Section 212 IA 1986	227-232
M, Application of Principles to the Facts	233-277
(i) Mrs Holland	233
(ii) Mr Holland - Overview	235
(iii) Period up to 19th August 2004	239
(iv) Period after 18th August 2004	261
(v) Result	271

MARK CAWSON QC:

A Introduction

1. These proceedings concern 42 Originating Applications issued on 27^th July 2006 under Section 212 of the Insolvency Act 1986 ("IA 1986") by HM Revenue & Customs ("HMRC") against the Respondents, Michael Holland ("Mr Holland") and Linda Holland ("Mrs Holland"), who it is alleged were de facto directors of the 42 companies, the subject matter of the Originating Applications ("the Composite Companies"), each of which entered into administration on 19^th October 2004, and each of which subsequently entered into liquidation. For convenience, I refer throughout this Judgment to HMRC, although during the history of this matter the Inland Revenue was amalgamated with HM Customs & Excise to form HM Revenue & Customs.
2. HMRC is the only creditor of the Composite Companies, being a creditor in respect of unpaid higher rate Corporation Tax ("HRCT") that became payable in the circumstances referred to below. By the Originating Applications HMRC seek an order that Mr and Mrs Holland contribute to the assets of the Composite Companies in consequence of misfeasance and breach of duties on their part as "de facto" directors of the Composite Companies and in causing the latter, between April 2002 and their entry into administration in October 2004, to pay dividends totalling in excess of £13m to the non-voting contractor/employee shareholders thereof referred to below. HMRC realistically limits its claim to the amount of HRCT left unpaid in respect of each Composite Company, after giving credit for net realisations in their respective liquidation, namely approximately £3.5m.
3. The Composite Companies formed part of a corporate structure ("the Corporate Structure") set up on professional advice with a view to ensuring that none of the Composite Companies became liable for HRCT, and it is a feature of the proceedings that the claims only arise because that objective failed to be achieved.

B Representation

4. Mr Michael Green appeared for HMRC, Mr Peter Knox QC appeared for Mr Holland, and Mr Aidan Casey appeared for Mrs Holland.
5. I am grateful to them for their detailed and well argued oral and written submissions.

C Witnesses

6. HMRC called the following witnesses:

6.1 Mr John Simmonds ("Mr Simmonds"), formerly a Tax Inspector at HMRC's Liverpool Kingsway office;

6.2 Mr Martin Watson ("Mr Watson"), a Tax Inspector at HMRC's Wrexham office responsible for Corporation Tax processing;

6.3 Mr Llewellyn Williams ("Mr Williams") a Tax Inspector at HMRC's Wrexham office, who in early 2002 was undertaking the final consolidation period of his technical training;

6.4 Mr Mervyn Russell ("Mr Russell"), at all relevant times, and until his retirement in 2006, HMRC's Large Business Manager for North Wales;

6.5 Mr Hugh McGillivray ("Mr McGillivray"), a Tax Inspector at HMRC's Wrexham office;

6.6 Mr Matthew Powell ("Mr Powell"), Team Leader of HMRC's Service Company Unit based in Taunton.

7. The Respondents called the following witnesses:

7.1 Mr Holland;

7.2 Mrs Holland;

7.3 Mr Carl Newton ("Mr Newton"), a partner in the firm of Neil Myerson, Solicitors of Altrincham;

7.4 Mr Peter Rees ("Mr Rees"), a Chartered Accountant and Principal of the firm of Messrs Speechleys of Colwyn Bay.

8. Whilst I will comment on particular aspects of the evidence in due course, I make the initial observation that I do not consider that any witness was, to any material extent, seeking consciously to mislead the Court. I am mindful that most of the witnesses were dealing with events that took place some years ago, the Corporate Structure itself having been set up over nine years ago. There is thus the real possibility that whilst witnesses might have given the impression of being good and credible witnesses, their evidence might well be based upon an honest but false reconstruction and recollection of events. I have thus sought, where possible, to test the witness evidence against the contemporaneous documentary evidence, and the overall probabilities of the situation, cf. Greek Shipping v Sharp & Co. [1987] 1 Lloyd's Rep 207 at 215-216, per Lord Goff. I am assisted in the present case by contemporaneous documentation such as detailed file notes, and correspondence, and my analysis of the background to the case considers the same in some detail.
9. As to HMRC's witnesses, although Mr Watson's recollection as to whether and in what circumstances he might have seen Mr Rees' letter of 30^th March 2001 was not perfect, I consider that he, Mr Simmonds, Mr Williams and Mr Powell, were, subject to the above considerations, essentially good and reliable witnesses. I have, however, had more difficulty with the evidence of Mr Russell and Mr McGillivray, in particular in relation to events between 27^th May 2004 and 21^st June 2004 to which I shall return. Mr Russell, in particular, had an unfortunate tendency not to provide a straightforward answer to questions. Talking about his contemporary dealings with Mr Russell, Mr Rees says that he found it difficult to differentiate between what Mr Russell said and what he meant, and I share that difficulty. Whilst a more comprehensible witness, Mr McGillivray did adopt a somewhat formulaic approach to answering questions that was not always helpful.
10. In his annexure to HMRC's written Closing Submissions Mr Green draws my attention to a number of passages in his evidence, and other matters that it is suggested reflect adversely on Mr Holland's credibility, including in particular some confusion between his evidence in chief and his evidence under cross examination with regard to limiting the profits of the Composite Companies to below £150,000 and the somewhat misleading statement on the current "Paycheck" website that "Paycheck" had "for the past 10 years ... worked alongside the Inland Revenue preserving our compliant service". However, giving due allowance for the passage of time, and the inevitable pressure that Mr Holland was under giving evidence, and having regard to his general demeanour in the witness box and the totality of his evidence, I am satisfied, despite the matters identified by Mr Green, that Mr Holland was an honest witness doing his best to recall events going back over many years and that, subject to the above considerations as to reconstruction and recollection, a reliable witness.
11. Likewise I am satisfied that Mrs Holland was, subject to the same considerations, a good and reliable witness.
12. Mr Newton struck me as a conscientious Solicitor doing his best to assist the Court. He gave evidence in a careful and measured way. However, I do bear in mind that Mr Newton was one of the architects of the Corporate Structure that ultimately failed to achieve its objective, and I am concerned that there is a real possibility that Mr Newton may, in certain limited respects, and albeit subconsciously, have imperfectly reconstructed events in his mind in such a way as to seek to justify his contemporaneous actions.
13. Mr Rees was a somewhat less guarded witness, quite prepared to take points against himself where appropriate to do so. Subject to the considerations referred to above, and notwithstanding the concerns expressed in paragraph 143 below as to his letter to Barclays Bank Plc dated 25^th August 2004, I found him to be a generally good and reliable witness.
14. Mr and Mrs Holland also rely upon the unchallenged contents of a short witness statement of Nigel Ginniff ("Mr Ginniff"), Barrister at Atlantic Chambers, Liverpool dealing with his conversation with Mr Simmonds referred to below.

D Corporate Structure

15. Before dealing in some detail with the factual background, I shall first describe the Corporate Structure and the tax difficulties, and the gist of HMRC's allegations against Mr and Mrs Holland against which the factual background is to be considered.
16. Mr and Mrs Holland operated as their trading company Paycheck Services Limited ("Paycheck Services"), of which Mr and Mrs Holland were each directors and in which they each held 50% of the issued share capital. Paycheck Services itself held 100% of the issued share capital of Paycheck (Directors Services) Limited ("Paycheck Directors") and Paycheck (Secretarial Services) Limited ("Paycheck Secretarial").
17. Paycheck Directors and Paycheck Secretarial were incorporated to act as sole corporate director and company secretary respectively of each of the Composite Companies, and Mr and Mrs Holland were each appointed as directors of Paycheck Directors and Paycheck Secretarial.
18. The issued share capital in the Composite Companies comprised one voting "A" share, and approximately 50 non-voting shares, each of a separate class (ie. "B1", "B2", "C1", "C2", "D1", "D2" etc shares). The A share was held by Paycheck Services Trustee Limited ("PST"), a company of which Mr and Mrs Holland were each directors and in which Mr and Mrs Holland each held 50% of the issued share capital.
19. The A share, in each Composite Company, was held by PST pursuant to a Trust Deed that provided for the A share to be held for the benefit of the Composite Companies' "Members", ie. the shareholder/ employee holders of the non-voting shares. The settlor under each Trust Deed was Mr Holland to whom the A shares had originally been allotted.
20. The non-voting shares were, in the case of each Composite Company, held by approximately 50 shareholders/employees, each such shareholder/ employee holding one each of the separate classes of shares referred to above.
21. Article 8(b) of the Composite Companies' Articles of Association provided that:

… "non-voting shares shall carry the right to the receipt of such dividends payable on each such class of shares, in such amounts, at such frequency, at such times as, on the recommendation of the Directors, the holder of the "A" share shall in General Meeting resolve in accordance with the following:

(aa) Subject to the provisions of the Act and to the following provisions of this Article, the Company may by Ordinary Resolution passed at a General Meeting upon the recommendation of the Directors, declare a dividend for any class of the non-voting shares ...

(ee) When paying interim dividends, the Directors may make payments of interim dividends to one or more classes of non-voting shares to the exclusion of one or more other classes of non-voting shares ...

(ff) Regulations 102 and 103 of Table A shall be read and construed accordingly with the foregoing provisions of this Article."

22. The intention behind the Corporate Structure and the Composite Companies was to provide the same tax advantages to the non-voting shareholders/employees as they would have enjoyed had they each set up individual service companies, but with the advantage that, because the relevant individuals fell within the umbrella of the Paycheck structure, with Paycheck Services providing the relevant administrative support, they were relieved of the administrative burden of operating individual service companies.
23. The Composite Companies contracted out the services of the shareholders/employees, typically through employment agencies, and out of the income received in respect of each such shareholder/employee, paid:

23.1 A fee to Paycheck Services for the administrative services provided by the latter;

23.2 A salary to the shareholder/employee typically limited to the minimum wage, and PAYE and National Insurance associated therewith; and

23.3 After making provision for payment of lower rate Corporation Tax, but not HRCT, a dividend to the shareholder/employee.

24. Dividends were paid to shareholders/employees on a regular ongoing basis. The shareholders/employees would put in time sheets for the work that they had done, the relevant figures were entered into Paycheck Services' computer, and the accountancy software thereon then calculated the dividend payable having made provision for the items referred to in paragraph 23 above. The computer program would generate a document purporting to be a minute of a directors' meeting of the relevant Composite Company, recording as present "M Holland Paycheck (Director Services) Limited, L M Holland Paycheck (Secretarial Services) Limited", and purporting to resolve that a dividend of a specific amount be distributed to the specified shareholder/employee. The computer generated on the minute a copy of Mr Holland's signature, beneath which appeared "for and on behalf of Paycheck (Director Services) Limited".
25. It should be noted that Article 12(b) of each of the Composite Companies' Articles of Association specified that the minimum number of directors should be one, and that whilst there was only one director, the sole director should have authority to exercise all of the powers and discretion by Table A and the Articles expressed to be vested in directors generally.
26. Each Composite Company, through the computer program operated by Paycheck Services, maintained in relation to each shareholder/employee a "mini profit and loss account" recording the relevant figures behind the dividend payments. Taken collectively the mini profit and loss accounts produced in respect of each Composite Company's employees/ shareholders would allow one to ascertain the relevant Composite Company's overall financial position. Mr Rees prepared the Composite Companies' annual accounts and described the process as follows:

"Tony Ashton kept the records and I was given summarised bank statements and summaries showing … a summary of the mini profit and loss accounts for each man and I just prepared a balance sheet and profit and loss account from the information that Mr Ashton gave me."

As a tool for ascertaining profits available for distribution as dividends, Mr Rees described the mini profit and loss accounts as "much better than any form of management accounts or projections".

E Corporation Tax Difficulties

27. There was only advantage in being a non-voting shareholder/employee of the Composite Companies so long as the relevant Composite Company paid lower rate corporation tax for which there was a threshold limited to profits of £300,000 per annum. If the Composite Company were liable to pay HRCT, then that would necessarily reduce the level of the dividends that could be paid well below those that could have been paid had the shareholder/employees used individual service companies or a composite company forming part of a corporate structure that was only paying corporation tax at the lower rate.
28. The foundation for the £300,000 threshold is Section 13 of the Income and Corporation Taxes Act ("ICTA 1988") headed "Small Companies Relief". At the relevant time, this provided, so far as is material, as follows:

"(3) The lower and upper relevant maximum amounts shall be determined as follows -

(a) …

(b) Where the company has one or more associated companies in the accounting period, the lower relevant maximum amount is £300,000 divided by one plus the number of those associated companies ...

(4) ... For the purposes of this section a company is to be treated as an "associated company" of another at a given time if at that time one of the two has control of the other or both are under the control of the same person or persons.

In this sub-section ("control") shall be construed in accordance with Section 416."

29. Section 416 ICTA 1988 then provided, so far as is relevant, as follows:

"(2) ... a person shall be taken to have control of a company ... if he possesses …

(a) The greater part ... of the voting power of the company;

(6) For the purposes of subsections (2) and (3) above, there may also be attributed to any person all the rights and powers ... of any associate of his ... any such attributions shall be made under this subsection as will result in the company being treated as under the control of five or fewer participators if it can be so treated."

30. Section 417(1) ICTA 1988 then provided that "a participator" is, in relation to any company, a person having a share or interest in the capital or income of the company "including (a) any person who possesses, or is entitled to acquire, share capital or voting rights in the Company ..."
31. Further Section 417(3) ICTA 1988 provided that "associate" meant "… (5) the trustee or trustees of any settlement in relation to which the participator is … a settlor".
32. The above structure was, in the circumstances that I describe below, set up on the basis of an acceptance that, as a matter of the strict application of Sections 13 and 416 ICTA 1988, the Composite Companies were associated through the fact that PST controlled each of them. However reliance was placed on Extra Statutory Concession C9 ("ESC C9") for maintaining that the Composite Companies should not be treated as "associated". ESC C9 provided, so far as is relevant, as follows:

"Nor will the Revenue treat one Company as being associated with another because they are controlled by the same trustee by virtue of the rights and/or powers held in trust by that trustee provided there is no past or present connection between the companies other than those rights and/or powers"

33. ESC C9 was subject to the usual proviso that a concession would not be given in any case where an attempt was made to use it for "tax avoidance".
34. There are issues as to whether reliance on ESC C9 was liable to be defeated by there having been a "past or present connection", or by virtue of ESC C9 being used for "tax avoidance". However it is now common ground, at least with the benefit of hindsight, that reliance on ESC C9 was doomed to fail because, by virtue of the operation of Section 417(3) ICTA 1988, Mr Holland, as settlor of each of the A shares, was to be treated as being in "control" of the Composite Companies, and ESC C9 did not purport to extend to common control by others than trustees of the kind therein specified.
35. Thus, on proper application of the relevant statutory provisions, because the Composite Companies were to be treated as associated, and because the collective turnover exceeded the £300,000 threshold, they were each liable for HRCT. Because dividends had been paid after only making provision for lower rate corporation tax, there is a substantial deficiency in the liquidation of each of the Composite Companies in respect of this HRCT liability.

F Outline of Allegations

36. In paragraph 16 of the Particulars of Claim, HMRC alleged that although Mr and Mrs Holland were not de jure directors of the Composite Companies, and Paycheck Directors was, Mr and Mrs Holland were de facto directors of each of the Composite Companies. Sub-paragraph 16(a) to (j) set out the factors relied upon in support of this assertion:

"(a) The Paycheck Services' business was and has at all material times been owned and controlled by Mr and Mrs Holland;

(b) They were the originators of the new Paycheck Composite Companies corporate structure and it was they who sought and received professional advice as to that structure;

(c) They deliberately installed Paycheck Directors as the de jure director in each Paycheck Composite Company to make it appear that they were distancing themselves from control; the reality was that, despite the structure, they still controlled and managed each Paycheck Composite Company;

(d) They were the sole directors of Paycheck Directors;

(e) They were also the sole directors of Paycheck Services, Paycheck Trustees and Paycheck Secretarial;

(f) Paycheck Directors and Paycheck Secretarial were "dormant" (see paragraph 2 of Neil Myerson's letter dated 2^nd February 1999 and paragraphs 5 and 11 of Mr Ginniff's Advice dated 22^nd January 1999) and controlled by Mr and Mrs Holland (para 7 of the Advice); thus, of necessity, the only human controllers of the Paycheck Composite Companies must have been Mr and Mrs Holland;

(g) They were the settlors of the trust of the voting "A" share in each Paycheck Composite Company; Mr Ginniff was of the view that their ownership of Paycheck Trustee and their control of Paycheck Directors and Paycheck Secretarial deemed them to have control of each Paycheck Composite Company (see para 7 of the Advice); this was later confirmed by legal advice received in August 2004 (see below) and was HMRC's view;

(h) Mr Ginniff made it clear that the structure was designed "to retain effective control of each company within the structure …" (para 17);

(i) They were the sole persons actually directing the affairs of the Paycheck Composite Companies;

(j) In particular, they could have been and were the only persons who decided on behalf of each Paycheck Composite Company how much to distribute to each employee/shareholder by way of dividend and how much to reserve or provide for their corporation tax liabilities."

37. HMRC then in paragraph 17 of the Particulars of Claim, alleges that Mr and Mrs Holland, as de facto directors, owed the following duties to each Composite Company, namely:

"(a) To act at all times in the best interests of each particular Paycheck Composite Company, including their creditors;

(b) To act with all the reasonable skill, care and diligence to be expected of directors in their position;

(c) Not to cause or allow any Paycheck Composite Company to pay dividends when it has insufficient distributable reserves;

(d) To ensure that the Paycheck Composite Companies retained sufficient funds or the ability to pay all its creditors, including its contingent or prospective creditors and HMRC;

(e) Not to continue to trade whilst insolvent".

38. In paragraph 34 of the Particulars of Claim it is alleged that Mr and Mrs Holland "were guilty of misfeasance and in breach of their duties as directors" of the Composite Companies as follows:

"(a) Despite being notified on 24^th April 2002 of HMRC's decision in relation to the application of ESC C9, they caused each of the Paycheck Composite Companies to pay out all of their available cash by way of dividends on the false assumption that each such company would only be liable for the small companies' corporation tax rate; each Paycheck Composite Company was left with insufficient reserves with which to meet any further liability for the higher rate of corporate tax that HMRC had determined must be paid;

(b) In the premises they caused the Paycheck Composite Companies to pay unlawful dividends there being insufficient distributable reserves within each such company after reasonably and prudently providing for the likely liability to increased corporation tax;

(c) Even after receiving the two Opinions of Counsel in August 2004, they caused the Paycheck Composite Companies to continue to trade and pay dividends while knowing that such companies were thereby being rendered insolvent with no reasonable prospect of avoiding insolvent liquidation;

(d) They failed to act in the best interests of each of the Paycheck Composite Companies (including their creditors, particularly HMRC) and failed to exercise the reasonable skill and care to be expected of directors in their position."

G The Principal Issues

39. It is common ground between the parties that the principal issues between them are:

39.1 Whether Mr and/or Mrs Holland were de facto directors of the Composite Companies;

39.2 If either or both of Mr and Mrs Holland were de facto directors, whether by causing the Composite Companies to pay dividends they acted in breach of their duties as de facto directors;

39.3 If either or both of Mr or Mrs Holland did act in breach of duties owed to the Composite Companies, whether they ought to be relieved from liability pursuant to Section 727 of the Companies Act 1985 ("CA 1985") or by the exercise of any discretion under Section 212 IA 1986.

40. Various other sub-issues arise that I consider below.

H Factual Background

(i) 1998

41. Mr Holland initially operated just one Composite Company known as Paycheck Services Limited, but subsequently renamed Paycheck Services 2 Limited ("Paycheck Services 2"). However, by late 1998 its annual profits were approaching £400,000 and had thus reached the stage that it had become liable for HRCT, its profits exceeding £300,000 per annum. Concerned that his then accountant Malcolm Matravers ("Mr Matravers") had not set up the right structure, Mr Holland approached Mr Newton, and met (together with Mr Matravers) with Mr Newton on 27^th November 1998. As Mr Newton's notes of the meeting show, at that stage Mr Newton "suggested" a structure similar to that described in paragraph 15 et seq above, but with only one Composite Company.

(ii) 1999

42. On 12^th January 1999 Mr Newton wrote to Mr Matravers setting out "an explanation of the structure we consider we should put in place in respect of Paycheck Services Limited". The structure described was, in essence, that described in paragraph 15 et seq above. The letter concluded:

"Our prime concern is to ensure that each composite company is not an associate of all the other composite companies. We have reviewed the definition of "associated company" set out in Section 416 ICTA 1988 which is applicable to Section 13(3) of ICTA 1988, and it would seem that, if the relationship of companies is as set out above, then prima facie the composite companies would be associated. However, ESC C9 (see copy attached) states that the Revenue will not treat one company as being associated with another because they are controlled by the same trustee company by virtue of rights and/or powers held in trust by that trustee, provided that there is no past or present connection between the companies other than those rights and/or powers. We believe that by applying this extra statutory concession, each of the composite companies to be formed by Mike will not be regarded as being associated."

Unfortunately, the point in relation to Section 417(3) ICTA 1988 referred to in paragraph 34 above was not spotted or appreciated.

43. On 18^th January 1999 Mr Newton instructed Mr Ginniff to advise on the structure that he (Mr Newton) had devised, and in particular in relation to the "association" point that he had identified in his letter to Mr Matravers. Mr Ginniff was known to Mr Newton as Counsel experienced in tax matters, and a former Inspector of Taxes.

.

44. Mr Ginniff advised by way of an Advice dated 22^nd January 1999. The Advice does, unfortunately, contain a number of apparent contradictions. At paragraph 10 Mr Ginniff, having made the point that extra statutory concessions are not given in any case where an attempt is made to use it for tax avoidance, expressed the opinion that there was a "considerable risk" that the proposed structure "will be interpreted as tax avoidance and that paragraph 4 of ESC C9 will not be available to the Companies". However, for reasons that are not made clear, he expressed the view that "this risk is much less when considering whether the various Composite Companies are associated with each other".
45. Thus in paragraph 16 of his Advice, whilst expressing the view that "… The proposed structure relies on the interpretation of ESC C9 and convincing the Inland Revenue that it is not being used for tax avoidance", and that "Tax avoidance is obviously achieved" goes on to conclude:

"Having said this I believe ESC C9 is likely to be available in the proposed structure for avoiding any associated company status between the Composite Companies. ESC C9 is specifically designed for this and there is no other connection, past or present between these companies. I am considerably less hopeful that the Composite Company will not be regarded as an associated company with New Paycheck (and PDS, PSS and the Trustee Company, apart from the fact that these companies should be accepted as dormant). This is because of the very close control between these companies and the commercial and other connections."

The Advice was faxed to Mr Holland on 22^nd January 1999.

46. As Mr Ginniff had said that he would in his Advice, on 26^th January 1999 Mr Ginniff spoke to Mr Simmonds, then an Inspector of Taxes at HMRC's Kingsway District, Liverpool. Although Mr Simmonds suggested that he would have shied away from discussion about anything involving trusts, he did state in evidence that he had no reason to doubt the accuracy of the relevant parts of Mr Ginniff's note of the conversation, which was itself confirmed by Mr Ginniff's unchallenged witness statement. This note recorded Mr Simmonds as having returned a call made by Mr Ginniff, which Mr Simmonds accepted he would have done after he had read ESC C9. The note refers to Mr Ginniff stating that he wished to discuss the interpretation of ESC C9, and to Mr Ginniff outlining the Corporate Structure, albeit without referring to Mr Holland as common settlor. The note then records Mr Simmonds as having confirmed that (on the information that he had been provided with) "he believed ESC C9 did cover the structure and the new companies would not be treated as associated" and that "... in his opinion, ESC C9 similarly covered the relationship between the trust company and the companies providing services so that they would not be treated as associated."
47. A telephone file note made dated 26^th January 1999 records that Mr Newton telephoned Mr Holland and: "Explained the Inland Revenue response". The note then recorded: "Go ahead on the basis that each Composite Company will do £150K of profits only", ie. with a view to preventing a liability to HRCT in the event of association between the Composite Companies and Paycheck Services.
48. On 2^nd February 1999 Mr Newton wrote a detailed letter of Advice to Mr and Mrs Holland the purpose of which was expressed "to be to set out the legal position as regards the use of this structure".
49. Whilst making clear that an opinion given by an Inspector of Taxes would not be binding, the letter stated this:

"You will see from Counsel's Advice regarding the structure that Counsel is of the view that there is considerable risk that the proposed structure will be interpreted as tax-avoidance and that paragraph 4 of ESC C9 will not be available to the company. However, Counsel states that he believes that the risk is much less when considering whether the various composite companies are associated with each other. Please note that Counsel gave this advice prior to him "passing" the situation by an Inspector of the Inland Revenue, who is used to dealing with the application of ESC C9. Counsel has reported to me that the Tax Inspector with whom he spoke gave a positive opinion as regards our proposed structure and confirmed that, in his view, the composite companies would not be regarded as being associates of each other and that Paycheck Services Limited would not be regarded as being an associate of each and every composite company. I have requested Counsel to forward a note to me of such conversation, but I have not yet received it. As soon as I receive it, I shall pass it to you."

50. The letter went on to say that until the Inland Revenue had reviewed and agreed to tax computations for the first financial year each of Paycheck Services and each Composite Company "neither our firm, your accountants nor Counsel can give you any guarantees that the Inland Revenue will not try to attack your Composite Company structure with a view to trying to tax the whole of the profits made by each Composite Company and Paycheck Services as one". Given the perceived greater risk of association between each Composite Company and Paycheck Services, the letter advised restricting the profits of each Composite Company and Paycheck Services to £150,000 each.
51. The letter was signed by way of acknowledgement by Mr and Mrs Holland on 2^nd February 1999.
52. On 8^th February 1999 Mr Newton wrote to Mr and Mrs Holland enclosing precedent documents for the setting up and running of the various Companies, including a form of resolution of the Board of the Composite Companies resolving to pay dividends to shareholders/employees.
53. On 2^nd March 1999 Mr Newton wrote to Mr Holland at Paycheck Services enclosing a note of Neil Myerson's charges for "advising the Company on the formation of the Paycheck Services Composite Company structure", and also enclosing a copy of Mr Ginniff's note of his conversation with Mr Simmonds.

(iii) 2000

54. Between November 2000 and February 2001, Speechleys, who had by then been retained as Paycheck Services' and the Composite Companies' Accountants submitted Accounts and Corporation Tax Returns that were ultimately forwarded to HMRC's Wrexham office.

(iv) 2001

55. A letter from Mr Rees (Speechleys) to Mr Newton dated 21^st March 2001 refers to Speechleys having "today received an informal telephone call from Wrexham 1 Tax Office asking us to explain the whole structure and advise them of the details of the parent company".
56. On 21^st March 2001 Mr Watson wrote to Speechleys in relation to Composite Companies numbered 7, 8 and 10. His letter stated that a detailed profit and loss account was required and also that "I would expect your notes to indicate if these companies are grouped or associated".
57. By letter dated 26^th March 2001, Mr Rees responded to Mr Watson's letter dated 21^st March 2001 dealing with the point about a detailed profit and loss account, and stating that:

"As the companies are not grouped/associated, we fail to see the need to make a note to this effect on the face of the accounts".

The letter contained the following "PS":

"We are writing under separate cover to your office explaining the whole Paycheck Services Limited set up - this should be in your hands within the next 14 days".

58. Mr Rees also drafted a detailed written response to the "informal telephone call" that was approved by Mr Newton in a letter to Mr Rees dated 30^th March 2001 that also advised that Paycheck Services and each of the Composite Companies should try to ensure that their profits did not exceed £150,000, for the reasons explained above, until such time as HMRC had accepted that Paycheck Services and the Composite Companies were not connected.
59. Mr Rees provided the detailed written explanation to "HM Inspector of Taxes, Wrexham 1" by letter dated 30^th March 2001. This began by referring to "our telephone conversation last week with your Mrs Williams". The detailed explanation included express reference to the fact that "The "A" share in each company is held by a trust which was set up by Mr and Mrs Holland", ie. pointing to a common settlor.
60. A meeting took place on 10^th April 2001 attended by Mr Holland, Mr Rees, Mr Newton and Mr Newton's assistant, Mr Akeel Latif ("Mr Latif"). The risk of the Composite Companies being treated as associated was discussed. Mr Newton expressed the view that any case brought by HMRC would be a test case and "should be resisted strongly". There was also a discussion in relation to the by then insolvent position of Paycheck Services 2 that I will return to.
61. On 27^th April 2001 Mr Watson wrote to Speechleys a letter headed "Paycheck Services 7, 8 and 10 Limited". The letter began:

"I refer to your letter dated 26^th March 2001, which was received on 6^th April 2001".

After dealing with the question of detailed profit and loss accounts, the letter continued:

"Indeed your comments concerning whether they are grouped or associated is correct, however, my comments were made before receiving your explanatory letter to that effect".

62. There was no other reply or response to Speechleys' letter dated 30^th March 2001, and it was Mr Rees's evidence that he took Mr Watson's letter dated 27^th April 2001 as being a response to both Speechleys' letter dated 26^th March 2001 and to the more detailed explanatory letter dated 30^th March 2001, and as being HMRC's acceptance that, certainly in relation to the Composite Companies numbered 7, 8 and 10, there was no question of association. However, it was Mr Watson's evidence that he was only concerned with processing and not investigation, that his enquiry as raised in his letter dated 21^st March 2001 was answered to his satisfaction by Speechleys' letter dated 26^th March 2001, that he did not contemporaneously see Speechleys' letter dated 30^th March 2001, and that if he had intended to refer to the letter dated 30^th March 2001 he would have expressly made this clear in the letter dated 27^th April 2001.
63. However, Mr Williams, who began an investigation in early 2002 as referred to below, when provided in early 2002 with copies of Speechleys' letter dated 30^th March 2001 and Mr Watson's letter dated 27^th April 2001, but not seemingly Speechleys' letter dated 26^th March 2001, assumed that the letter dated 27^th April 2001 was referring to the letter dated 30^th March 2001. Mr Williams also says that he recalls taking the copy of the letter dated 30^th March 2001 that he was provided with to Mr Watson who responded that it appeared to him that he had responded to the letter dated 30^th March 2001 with the letter dated 27^th April 2001. However, at that stage, the letter dated 26^th March 2001 may not have been available to show to Mr Watson as it was not sent together with copies of the letters dated 21^st March 2001 and 27^th April 2001 to Mr Williams under cover of Speechleys' letter dated 13^th March 2002. Mr Williams commented that he thought it highly unlikely that Mr Watson would answer the letter dated the 30^th March 2001 off his own back, and that it was possible that he was asked by somebody to send the letter dated 27^th April 2001, and further that the likelihood is that he would have mentioned it to Mr Russell.
64. Mr Russell was recalled to be cross-examined on this matter after the late disclosure of an undated briefing note prepared by Mr Williams for Mr Russell in early 2003. This briefing note, at one point, referred to the fact that "All the open enquiries can be closed as NIL due to Martins (sic) [ie. Mr Watson's] letter (advised by Jones [or James- the writing is unclear]) saying that ESC C9 did apply". On one reading, this suggests that Mr Watson was instructed by "Jones" or "James" to send the letter dated 27^th April 2001 in response to Speechleys' letter dated 30^th March 2001.
65. The reference in Mr Watson's letter dated 27^th April 2001 to "explanatory letter", the absence of any other response to the letter dated 30^th March 2001, the reference in Mr Williams' briefing note to "Martin's letter (advised by James [or Jones]), and Mr Williams' evidence as to his conversation with Mr Watson leads me to conclude, on balance, that Mr Watson's letter dated 27^th April 2001 was intended to be written in response to the letters dated 26^th March 2001 and 30^th March 2001 and that Mr Watson wrote the letter dated 27^th April 2001 after at least some internal discussion.
66. However, what I consider to be of far more significance for present purposes is that HMRC, by the way that the letters dated 26^th March 2001 and 30^th March 2001 were dealt with, clearly led Mr Rees, and through him Mr Holland, to believe that HMRC was content, in the light of a detailed explanation common to all the Composite Companies, that there was no "association". Further, whilst under the self assessment regime this all occurred at the processing stage rather than the formal enquiry stage, the self assessment regime was then new, and of course the letter dated 27^th April 2001 was sent after a detailed explanation had been asked for and given.
67. Of course it would have been open to HMRC at any time after the sending of the letter dated 30^th March 2001 and the reference therein to the trust being set up by Mr and Mrs Holland (in fact only Mr Holland) to take the point under Section 417(3) ICTA 1988 that was not, in fact, taken until HMRC's letter dated 25^th June 2004 sent over 3 years later.
68. On 1^st November 2001, Mr Rees wrote to Mr Newton with regard to Paycheck Services 2, which ultimately entered into liquidation on 15^th April 2003. The Directors' history prepared for the meeting of creditors of Paycheck Services 2 held on that day referred to the directors (in fact only Mr Holland as he was the only director) discovering in November 1998 that turnover exceeded £300,000, but that trading had continued to July 1999, resulting in a deficiency of £67,000 in respect of HRCT, in fact incurred because Paycheck Services 2 had continued to trade paying dividends to shareholders/employees without making provision for the HRCT.
69. Mr Rees' letter dated 1^st November 2001 raised the question of the deficiency, and the fact that Paycheck Services 2 had "borrowed" from certain of the Composite Companies thus raising questions as to the solvency of these Composite Companies, as well as to "control/association" in the context of Section 416 ICTA 1988. A file note dated 2^nd November 2001 refers to Mr Newton advising Mr Holland to take Counsel's opinion. No such opinion was taken, but there is an internal Neil Myerson note recording Mr Latif as noting that Mr A J Cockerill, another partner of Neil Myerson, had advised on 5^th November 2001 that the loan would not give rise to association. Further, as evidenced by the estimated statement of affairs of Paycheck Services 2 as at 18^th April 2003 and the reference therein amongst creditors to "Directors loan account", Mr Holland advanced monies to Paycheck Services 2 that enabled the loans from the Composite Companies to be repaid. Thus Mr Rees' concerns were alleviated. However, it is to his credit that Mr Rees took the point that he did.

(v) 2002

70. Nothing was heard from HMRC further to Mr Watson's letter dated 27^th April 2001 until, on 11^th February 2002, Mr Williams wrote a series of letters to Paycheck Services, all the Composite Companies and to Speechleys, informing them that he intended to enquire into tax returns for the period 1^st August 1999/31^st July 2000. In the letters to Speechleys, Mr Williams commented that:

"It appears from the information at my disposal that there are however other associated companies. I would welcome your comments as to why the full rate of CT has not been paid".

71. Speechleys responded by letter dated 13^th March 2002. This stated, so far as is relevant, as follows:

"(1) Small Companies Relief - in our letter of the 30^th March 2001 (copy enclosed) we advised you why the various companies were not associated for the purposes of marginal rate relief and indeed your Mr Watson indicated in his letter of 27^th April 2001 (copy enclosed - penultimate paragraph) that you were in agreement with the thinking/reasoning set out in our letter. Consequently, it is not really understood why you are now resurrecting this particular query nearly 12 months later."

72. Mr Williams responded by letter dated 24^th April 2002 noting that Speechleys had previously been informed by Mr Watson concerning the association of the companies, and stating that he was to "research the matter" but that "in the meantime I need to inform you that it is my view that the companies are associated". The letter went on to comment that Mr Williams had "reservations about your view concerning the association of the companies", and that he would be "researching" this issue and one other "in conjunction with the cases of WT Ramsay v. CIR and NMB Holdings Limited v. The Secretary of State", ie. tax avoidance cases, and that he would "Contact you again in due course".
73. It is to be noted that the letter did not engage in the issues raised in the letter dated 30^th March 2001, and the application of ESC C9, and whilst the letter did conclude by saying that Mr Williams looked forward "to your comments in due course", the overall impression clearly given was that Mr Williams was looking into and researching the matter and would revert with a reasoned response in due course.
74. The letter is significant in the sense that it is HMRC's case that it is from 24^th April 2002, and not before, that Mr and Mrs Holland ought to be found liable for permitting the dividends to continue to be paid by the Composite Companies without making provision for HRCT.
75. Mr Holland was made aware by Mr Rees of this correspondence, but the gist of Mr Rees' advice was to the effect that Mr Williams was looking into the matter and would ultimately adopt the same approach as Mr Watson as reflected in his letter dated 27^th April 2001, and that HMRC had not come up with any reasoned argument to suggest that the reasoning in the letter dated 30^th March 2001 was wrong.
76. In a letter dated 9^th August 2002 Mr Williams sought to "make it clear that the information you previously received from Mr Watson was incorrect". He went on: "ESC [C9] was specifically introduced to help clearing banks and other professional trustees. The Paycheck Companies are associated for MSCR purposes and their returns should reflect this". The letter did, however, state that: "I am still researching these matters and a reply is not necessarily required at this stage."
77. Speechleys (Mr Rees) did, however, reply on 5^th September 2002 commenting that they could find no reference therein: "to the use of [ESC C9] being restricted to clearing banks and other professional trustees".
78. Mr Williams responded by a letter dated 10^th October 2002. This letter commented that ESC's were "generally brought in for specific reasons" and that such reasons were an "important factor". The letter also took a point about "past and present connections", based on Mr and Mrs Holland being "directors of all the Companies", and sought an "outline of the reasons for the insertion of the trust into the scheme of things". Mr Williams concluded by asserting that the companies should consider themselves associated for all returns submitted after Mr Williams' letter dated 24^th April 2002. By a subsequent letter dated 19^th October 2002 Mr Williams sought a representative copy of the trust deed.
79. Mr Rees replied by letter dated 28^th November 2002. This letter challenged the suggestion that there was any specific reason for its introduction that limited the application of ESC C9, pointed out that Mr and Mrs Holland were not directors of the Composite Companies, and referred again to the letter dated 30^th March 2001 as providing an explanation for the structure.

(vi) 2003

80. By letter dated 9^th January 2003 Mr Williams repeated his request for an explanation for "inserting the trusts into the structure for the Paycheck companies", and by a letter dated 5^th February 2003, Speechleys sought to provide the explanation - see in particular paragraph 8 thereof explaining that the Composite Companies had been set up for the benefit of the shareholders/employees. By letter dated 11^th March 2003, Mr Williams sought copies of documents that should have been provided under cover of the letter dated 5^th February 2003, and these were provided by Speechleys under cover of a letter dated 2^nd April 2003.
81. There was then no significant communication from HMRC until Mr McGillivray wrote on 4^th December 2003 opening formal enquiries into the claim for marginal rate relief made by all the Composite Companies in their tax returns for the year ended 31^st July 2002.
82. Further, on 8^th December 2003, Mr McGillivray wrote to Speechleys apologising for the delay in responding to Speechleys' letter dated 2^nd April 2003, and stating that they would soon be receiving closure notices for the enquiries into the accounting period ended 31^st July 2000 and 31^st July 2002, and assessments for the year ended 31^st July 2001, it being made clear that these were on the basis of HRCT being due given the matters "covered in the correspondence with … Mr Williams, and regards the relationship between the Paycheck Companies".
83. In the meantime Mr Williams had handed over the file to Mr Russell, and also effectively to Mr McGillivray who worked under Mr Russell, and Mr Williams had prepared the briefing note referred to above. This briefing note rehearsed the respective arguments as follows:

"Appellants Anticipated Arguments

i, They were informed by our office that ESC C9 applied to them.

ii, That there is no past or present connection between the companies other than those rights or powers held in trust.

iii, That Mr and Mrs Holland's involvement as directors of Paycheck Director Services Ltd and Paycheck Secretarial Services Ltd is irrelevant to the issue of association as these are dormant companies which have never traded.

iv, The structure has not been devised for as a means of avoiding tax.

Revenue Arguments

i, Unfortunately the Company is correct, we did tell them that ESC C9 applied and therefore there is nothing we can do about the AP 31 July 2000. The Company was told that this information was incorrect in a letter dated 24 April 2002 which was prior to submitting the 2001 accounts on 31 July 2002, but chose not to follow that advice.

ii, The crucial wording in ESC C9 is 'provided there is no past or present connection between the company and the trustee company'. All the Paycheck Companies have common directors in Paycheck Directors Ltd and I think that is enough to show there is a connection. Mary Sharpe at BT was also of the opinion that the ESC did not apply but did not outline exactly what her reasoning was. Although she indicated that the ESC was designed for professional trustees such as banks.

iii, The fact that Paycheck (Director Services) Ltd has not traded is thought to be irrelevant.

iv, The agent's letter dated 5 February gives a much fuller reply than previously received. However, I can still see no reason for the insertion of the trusts other than to avoid association and therefore taxation."

84. Further, by letter dated 13^th January 2003 Mr Rees had written to Mr Newton raising three matters that he considered required "addressing urgently", namely:

84.1 "The fact that" by 31^st July 2002 Paycheck Services Limited had "borrowed" £86,370 from individual Composite Companies "…- can this situation be classed as anything other than association for the purposes of Section 416 of the Taxes Act";

84.2 That £30,000 remained outstanding and due from Paycheck Services 2 to five Composite Companies; and

84.3 The correspondence "between ourselves and the Revenue with regard to the overall structure of Paycheck".

85. Mr Rees had not, after March 2002 and prior to this letter, been in contact with Mr Newton. A meeting was arranged for 21^st January 2003 at Neil Myerson's office between Mr Rees, Mr Newton, Mr Holland and Mr Ashton, and Mr Newton prepared an Agenda referring to the matters raised in Mr Rees' letter dated 13^th January 2003, and raising the question as to whether the "deficit" ie. the matters referred to in paragraph 84.1 above should be treated as loans or fees.
86. The meeting took place, and on 4^th February 2003 Mr Newton wrote to Mr Holland "setting out the issues that we discussed at the meeting" on 21^st January 2003. This letter was disclosed late in the day, and parts of it remain redacted as being subject to legal advice privilege. The letter shows that Mr Newton advised that the loans to Paycheck Services 2 be regarded "as a matter of priority and urgency" on the basis that such loans did point to an association.
87. The "deficit" referred to in paragraph 84.1 above disclosed something of a dilemma. The deficit reflected administrative fees that had been incurred by Paycheck Services, but not paid because provision had not been made for the same, and which it had been anticipated could be paid by interest earned by the Composite Companies which had not in fact been earned. If treated as fees, then the Composite Companies could not afford to pay them, but if treated as a loan to Paycheck Services, then that would serve to strengthen HMRC's case as to "association". Mr Newton advised that the items could properly be and ought to be treated as fees.
88. In the event, and as explained above, by the time that Paycheck Services 2 entered into liquidation on 18^th April 2003 the Composite Companies were no longer creditors of the company. So far as the sums left owing by the Composite Companies in respect of fees were concerned, the evidence was that as a result of obtaining more favourable banking arrangements, the Composite Companies earned sufficient interest to enable the deficit to be discharged by June 2004.
89. It is a feature of the advice that Mr Holland received in January 2003 that it was not suggested to him that he should even consider not continuing to cause the Composite Companies to pay dividends without making provision for HRCT, or to cease trading.
90. One thus reverts, in the narrative, to the events following Mr McGillivray's letters/notices dated 4^th and 8^th December 2003.
91. On 11^th December 2003, and as confirmed by Mr McGillivray's attendance note, Mr McGillivray, on Mr Rees' enquiry, confirmed that a single "covering" letter of appeal would suffice. Mr Rees, seemingly without consulting Mr Newton, wrote a form of letter of appeal on 22^nd December 2003. The letter began as follows:

"Our understanding of the position is that you do not intend to raise (at this stage) any further points in support of your contention that the companies are associated but are relying on matters raised by your Mr Williams in previous correspondence (prior to our letter of 2^nd April 2003 to which your only reply is/has been your letter of 8^th December 2003 and we note in particular that you have made no comment on the contents of our letter of 5^th February 2003 other than requesting the matters referred to in our letter of 2^nd April 2003).

For the reasons previously explained in correspondence our clients do not accept that the companies are associated and hence should only be taxed at the "small companies' rate". In the circumstances please arrange an appeal meeting before the Special Commissioners to make a definitive ruling in this matter and advise us of the likely time scale/location in order that our clients can make appropriate arrangements in advance of the hearing."

In fact, unbeknown to Mr Rees, or indeed so it would seem to representatives of HMRC then dealing with the matter, any challenge to HMRC's refusal to accept that ESC C9 applied lay by way of judicial review, and not by way of appeal to the Special Commissioners.

(vii) 2004

92. Following further correspondence between Mr Rees and another Inspector of Taxes, Mrs J B Monroe ("Mrs Monroe"), with regard to procedure, Mr. Newton spoke to Mr Rees on the telephone on the 7^th January 2004. In this conversation Mr Rees referred to having spoken to "a Senior Tax Inspector at Wrexham" who had intimated that the matter had been looked at centrally by the Inland Revenue and that they had "decided to attack the Paycheck Scheme and other Composite Company Schemes on the basis that they are associated for taxation purposes". Mr Rees also mentioned that the Inland Revenue, proposed to change the rules with regard to national insurance so that it would no longer be possible for contractor shareholders to receive dividends and avoid national insurance in respect of dividends paid. On the same day, Mr Newton subsequently telephoned Mr Holland and discussed with him the matters that Mr Rees had raised. There was, in addition, discussion as to whether legal expenses insurance had been taken out by the relevant companies sufficient to fund a challenge by HMRC.
93. By letter dated 8^th January 2004, Mr Rees informed Mr Newton that the HRCT outstanding, if payable, exceeded £2M. It is clear from the evidence that Mr Holland was aware of the amounts involved. However, it was Mr Rees' evidence, which I accept, that he still believed that the Composite Companies had a good case, and his evidence was, which again I accept, that this was the impression that he would have conveyed to Mr Holland.
94. On 20^th January 2004 Mr Rees wrote to Mrs Munroe clarifying the basis of the appeals.
95. On 24^th February 2004 an important meeting took place attended by Mr Rees, Mr Newton, Mr Holland, Mrs Holland and Mr Ashton. This is the only formal meeting that Mrs Holland is recorded as having attended. It was suggested on behalf of HMRC that she only attended this meeting because of the serious position and because Mr Newton perceived the need to give her important advice as to her own personal position. However, Mr and Mrs Holland's evidence on the point, which I accept, is that she only attended the meeting because Mr Holland asked her to do so as they were going out for dinner afterwards. Mrs Holland had no real recollection of what was said at the meeting. She said in evidence that she would have listened to what was said, but would not have been interested as she considered that Mr Holland was "taking care of things".
96. Mr Newton's note of the meeting on 24^th February 2001 sets out several important matters discussed. In particular:

96.1 The deficit in respect of the fees due to Paycheck Services had almost been cleared.

96.2 Mr Rees reported that the outstanding assessments claimed approximately £2M additional corporation tax.

96.3 It was agreed that Neil Myerson should continue to act given that they had "devised the structure [taken] Counsel's opinion upon it and [had given] advice on the operation of the structure for the last five years".

96.4 Mr Holland asked Mr Newton whether or not the appeals would succeed, to which Mr Newton is recorded as having explained that:

"... Neil Myerson Solicitors have never been able to guarantee that the Scheme would work, but that in our view and in Counsel's view Extra Statutory Concession C9 applied to the Paycheck Services Composite Company structure and that the Inland Revenue have not been able to give any logical reason as to why it should not apply to such structure. The only thing that the Revenue has said is that extra statutory concession can only apply in relation to Banks. The statutory concession does not say that it only applies to banks. On this basis, CEN stated that he was hopeful that an appeal would be successful."

Cross-examined on the point, Mr Newton explained that Mr Rees, who he understood had had experience of dealing with the individuals at HMRC in question, was very confident that HMRC would change their minds, and that he was confident at the time that the scheme would work.

96.5 It was discussed that if the appeal against the assessments were lost, then approximately £2M corporation tax would be payable and the companies would have to be put into creditors' voluntary liquidation.

96.6 Mr Newton explained that "theoretically" the liquidator could bring a claim for wrongful trading/or repayment of unlawful dividends paid to members "against the Directors". However, Mr Newton is recorded as having suggested that "in view of the fact that Mike has been trading the Composite Companies in the honest belief that they were not associated and therefore the extra Corporation Tax liabilities would not be incurred, this could be a defence to a wrongful dismissal (sic) claim."

96.7 The possibility of director's disqualification proceedings was considered.

96.8 Mr Newton advised that he considered that it would be lawful for Paycheck Services Limited to declare a dividend "as Paycheck Services Limited does not at this time have any potential contingent liability for any claim that a liquidator of a Composite Company might bring should the appeal case be lost and the Composite Companies go into liquidation."

96.9 It was decided that in view of the fact that it was not known whether or not the rules with regard to National Insurance would change following the next budget that "the Paycheck Composite Companies should continue to trade in the normal way until 17^th March 2004", when a position statement on the issue was due. The note continued "if there is still some benefit in declaring dividends to contractors then it may well be that the Composite Company structures will continue based on the current structure…..CEN [i.e. Mr Newton] states that Paycheck Services needs to ensure that it has a system whereby it will cease to continue to pay dividends or alternatively reserve additional taxation that may be chargeable on dividends as from the date any changes made by the Chancellor come into effect".

97. It is, in my judgment, important to note that at no point was it suggested to Mr Holland that he should cause the Composite Companies to cease paying dividends without making full provision for HRCT, ie. in practical terms to cease to trade. As to the decision to continue to trade in the normal way until 17^th March 2004, Mr Newton said under cross-examination that this was a matter in respect of which he presented all the consequences, but that it was "the client's decision whether to continue to trade". However, Mr Rees described the decision as a collective decision, and I consider it likely that this is more reflective of what actually occurred with Mr Newton and Mr Rees having rather more input into the actual "decision" to continue trading than Mr Newton's evidence suggested. In any event the question of continuing to trade was only raised in the context of the possible change in the National Insurance regime and was not related to the potential liability for HRCT.
98. In the event the anticipated changes to the National Insurance regime were not made. On 7^th April 2004, Mr Newton spoke to Mr Rees who, Mr Newton said in evidence, remained confident that HMRC could and would be persuaded that they were wrong in their refusal to apply ESC C9. During this conversation Mr Rees informed Mr Newton that he had spoken to Mrs Munroe prior to the Budget and that she had acknowledged that it "might not be worth pursuing the case if the taxation of dividends changed", and "inferred" that HMRC might be "prepared to do a deal with Paycheck".
99. By a letter dated 18^th May 2004 Mr McGillivray sought to arrange a meeting with Mr Rees to "finalise the arrangements for the hearing of these appeals". Mr Rees telephoned Mr McGillivray on 24^th May 2004 to enquire about the purpose of the proposed meeting, and Mr McGillivray indicated that the purpose was to be to "agree the facts of the enquiry to take forward". The date of 21^st June 2004 was agreed for the meeting. On 27^th May 2004 Mr Rees telephoned to ask whether there was likely to be technical discussion at the meeting because, if so, Counsel would be asked to attend the meeting to represent the Composite Companies. Mr Rees asked to be informed if such was to be the case.
100. There were then two telephone conversations between Mr Rees and Mr Russell on 27^th and 28^th May 2004, and a meeting between Mr Rees and Mr Russell on 28^th May 2004 that are of some significance.
101. On 27^th May 2004, after one of the telephone conversations but before they met, Mr Rees wrote to Mr Russell setting out his understanding as to "the Revenue's stance on this matter". The letter noted HMRC's position that any challenge required to be by way of judicial review, and at paragraphs 3 and 4 continued:

"(3) You accept that Martin Watson conceded in his letter of the 27^th April 2001 that numbers 7, 8 and 10 are not associated (because these are the only 3 numbers referred to at the top of his letter) and you are therefore not seeking to challenge the fact that ESC C9 is valid/stands in the context of those 3 companies.

(4) As far as the other Paycheck companies are concerned (3 to 6 and 11 to 45) no specific request for C9 to apply was ever made in the manner which you are suggesting should have been the case in point '2' above. It is therefore the Revenue's stance that all those companies were/are associated and because no claim for ESC C9 was ever made there can be no judicial review/form of appeal against that decision at this moment in time".

When questioned on this letter, Mr Russell admitted that he would have agreed that Composite Companies numbered 7, 8 and 10 should be treated as not associated for any purposes, but only for the accountancy periods prior to HMRC qualifying Mr Watson's concession.

102. Mr Rees also made an attendance note of the telephone conversation to much the same effect. Further, by letter dated 28^th May 2004, Mr Rees wrote to Mr Newton enclosing a copy of his letter to Mr Russell and setting out the background to the discussion. He concluded the letter by saying that:

"My gut feeling is that they are "clutching at straws" - if the situation is as clear cut as Mr Russell is now trying to portray, why did they not take this stance in February 2002".

103. The letter from Mr Rees to Mr Newton referred to in paragraph 102 above was sent under cover of a fax header sheet that said: "When you have read this give me a ring as things have moved on".
104. A telephone attendance note dated 28^th May 2004 made by Mr Newton records Mr Rees as having reported that he had telephoned Mr Russell again. The note then continues:

"- said Watson made a mistake - then accepted PC3 - 40 not associated - will confirm in writing.

- PC 41 - 45 then he said accepted not associated - will withdraw assessments -

Revenue - want meeting to tie up loose ends."

105. Mr Rees then met with Mr Russell on 28^th May 2004. Given the difficulties that he had had with differentiating between what Mr Russell said and what he meant, and on Mr Newton's advice, following the meeting Mr Rees wrote to Mr Russell again setting out his understanding as to how HMRC's position had moved on. His letter said this:

"With particular reference to point 3 of that letter we pointed out that whilst Martin Watson's letter of the 27^th April 2001 specifically referred to Paycheck 7, 8 and 10 this was in reply to our letter of 26^th March 2001 (which specifically referred to Paychecks 7, 8 and 10).

The p.s. on that letter referred to our letter of 30^th March 2001 (which explained why we considered that companies 3 to 40 inclusive were not associated) and we pointed out that we found it hard to believe that Mr Watson did not have sight of this letter and indeed it was on the basis of the contents of that letter that his letter of the 27^th April conceded that the companies were not associated.

You accepted this line of argument and conceded that on that basis the Revenue accept that in addition to 7, 8 and 10 not being associated the rest of the companies involved (3 to 6 inclusive, 9 and 11 to 40 inclusive) are not associated.

We therefore look forward to your early written confirmation that you will now be withdrawing the additional assessments under appeal for all companies falling between numbers 3 and 40 which we believe are the only companies in respect of which additional assessments have been raised/appeals have been lodged.

With regard to numbers 41 to 45 we understand that at the meeting on 21^st June you and Hugh McGillivray are going to discuss with us the mechanics of correcting the technical situation on these companies in terms of formally enabling them to be treated as not being associated with any of the other Paycheck companies.

Paychecks 46 - 49 are in existence but have not traded at this point in time so we would hope to address that issue with yourselves at the forthcoming meeting."

106. Cross-examined on the meeting and Mr Rees' letter, Mr Russell said that his recollection was vague, but he felt that he could not possibly have said anything to the effect that HMRC accepted that none of the active Composite Companies were associated.
107. However, Mr Russell did not, on receipt of Mr Rees' letter dated 28^th May 2004 reply, or revert in any way to Mr Rees challenging the contents of Mr Rees's letters. Further, at 4.00pm on 28^th May 2004, Mr Russell sent an internal email to Mr McGillivray that said this:

"Developments and two long phone calls with Peter Rees and one meeting in Colwyn Bay. Couldn't get a hold of an expert at BT or CCP. Meantime if any one of the companies can demonstrate they have the cover of the Martin Watson acceptance of ESC C9 applying then we have to live with it.

Peter Reece has condensed my verbal advice to him (by phone 27/05/04) into his letter of 28/05/04 and I have agreed with him at the meeting that that position is the bottom line. If they can demonstrate that an individual company specifically or by reference to an agreement that we did not resile from then that further company also has the cover of ESC C9."

In addition it is common ground that it was discussed that the meeting on 21^st June 2004 was to be an "enabling meeting".

108. My overall impression of the telephone conversations and meeting on 28^th May 2004 is that Mr Rees genuinely believed, following his discussions with Mr Russell, that HMRC had, through Mr Russell, concluded that none of the active Composite Companies was associated, and thus that the meeting on 21^st June 2001 was simply to be to tie up loose ends, and that HMRC were, in any event "clutching at straws" in seeking to suggest otherwise. Further, it is clear on the evidence that Mr Rees' belief was shared with Mr Newton and, more importantly Mr Holland.
109. I consider it likely that Mr Russell did not perhaps intend to go quite so far as Mr Rees had understood him to go, but that it is regrettable that he did not then respond to Mr Rees' letter of 28^th May 2004. Nevertheless, as the email to Mr McGillivray demonstrates, Mr Russell clearly conceded that the effect of Mr Watson's concession might well be that other Composite Companies should be treated as not associated.
110. The meeting remained fixed for 21^st June 2004. It was Mr Rees' evidence that he spoke to Mr McGillivray on 18^th June 2004, and obtained confirmation that his letter dated 28^th May 2004 had been received, and that the discussion on 21^st June 2004 would just relate to Composite Companies numbered 41 - 45, and why Composite Companies numbered 45 - 50 "could not be run", ie. that HMRC would not be re-opening the associated status of Composite Companies numbered 31 - 40. Mr Rees' version of events is supported by Mr Newton's note of a telephone conversation with Mr Rees on 18^th June 2004 when Mr Rees informed Mr Newton as to what had been discussed with Mr McGillivray.
111. It is thus somewhat odd that Mr McGillivray should, as he did, have prepared a note for the meeting on 21^st June 2004 that referred to some of the relevant provisions of ICTA 1988 (but not Section 417(3)), and some analysis of the principles relating to judicial review, including the following:

"Appeals/Judicial Review - info from Internet

Commissioners can only decide on strict statutory position (R v. Brumfield 6 ITC 589)

"Legitimate expectation" to relief or benefit of concession (page 595) up to a point where told did not apply.

When giving notice - told in writing 9^th August 2003 advice was wrong then the future position was changed (68 TC 205 R v. Unilever page 220) return submitted prior - OK?

Position outside statutory normal but accepted by practice.

Position with Paycheck based on letter (wrong advice) but then told (confirmed advice wrong and did not apply) otherwise.

First two years covered - reduce o/s amount to nil.

Final year and carrying on - based on revised position.

Non-negotiable?"

112. The only rational conclusion that I feel able to come to is that there was either a misunderstanding between Mr Rees and Mr McGillivray on 18^th June 2004, the Friday before the meeting on 21^st June 2004, Mr McGillivray having carried on further research into the matter prior thereto, or that following his discussion with Mr Rees on 18^th June 2004, Mr McGillivray then researched the position on the internet and prepared the note that he did. In reaching this view I have not ignored the point advanced by Mr Green in cross-examination of Mr Newton that Mr Newton on 16^th June 2004, discussed with Joe Brown of Neil Myerson the appropriate appeal procedure, and in particular whether Neil Myerson might be responsible for the fact that judicial review had not been sought. This is a potential inconsistency between the carrying out of this exercise, and a belief at the time that HMRC was no longer challenging the position in relation to Composite Companies 3 - 40. However, I am satisfied that this was simply a belt and braces approach ahead of the meeting on 21^st June 2004 just in case HMRC changed its mind again, rather than being reflective of a real concern that HMRC would do so.
113. The meeting duly took place at Neil Myerson's offices in Altrincham between 11.00am and 1.30pm on 21^st June 2004. Those present were Mr Newton, Mr Rees, Mr Holland, Mr Ashton, Mr Russell and Mr McGillivray. Mr Newton made a shorter manuscript note that was later expanded upon to make a detailed attendance note, and Mr McGillivray prepared his own attendance note.
114. From the various accounts in evidence of the meeting, and the attendance notes, the following picture emerges. Mr Newton, Mr Rees and Mr Holland went into the meeting believing and understanding that matters had been resolved in relation to Composite Companies 3 to 40, and that the purpose of the meeting was to tie up loose ends and discuss the other Composite Companies. However, Mr Russell and/or Mr McGillivray made it clear early on that there must have been some misunderstanding, and that HMRC's position, the matter having been considered by its technical department, was that ESC C9 did not apply, but that HMRC recognised that Mr Watson's letter dated 27^th April 2001 might have affected HMRC's ability to collect in relation to earlier accounting periods on the basis that HMRC might be bound thereby until such time as HMRC changed its opinion as reflected in Mr Williams' letters.
115. Mr Russell was not in a position to give precise reasons for HMRC's contention that ESC C9 did not apply, as he had first to refer to HMRC's technical department. However Mr Russell did refer to the purpose of the structure as being to "avoid tax", albeit that Mr Russell made it clear that HMRC was prepared to consider further representations and arguments, and that he would provide a letter setting out HMRC's detailed reasoning.
116. Further, there was discussion as to the solvency of the Composite Companies, and as to the possibility of HMRC agreeing not to seek all the Corporation Tax that it might be entitled to in the event that it was correct. The following passage from Mr Newton's file note accurately sets out, in my judgment, the relevant discussions:

"Mr Russell then raised the issue of solvency. He stated that, if the Inland Revenue was right, an extra corporation tax of approximately £1.4m per accounting period would be payable by the Paycheck Services composite companies. He stated that he understood that the Paycheck Services composite companies would not be able to pay such tax and that there would be no point in chasing this if there is no prospect of it being paid. On that basis, Mr Russell stated that, from a practical point of view, the Inland Revenue might be prepared to change its mind as to the application of extra-statutory concession C9 in respect of past and current financial accounting periods, if it were to be accepted that, in respect of future accounting periods, extra-statutory concession C9 would not apply, and the composite companies would be taxed as being associates. CEN/Peter Rees asked Mr Russell to confirm that the Inland Revenue is basically stating that, if the structure of the Paycheck composite company structure is no longer operated but is effectively shut-down, then the Inland Revenue will no longer pursue additional corporation tax that they say is payable in respect of some past and current accounting periods. Mr Russell replied by saying that he is prepared to take a pragmatic approach. Mr Russell stated that, as the Inland Revenue has taken the view since 2002 that extra-statutory concession C9 does not apply, the directors should consider the issue of solvency. CEN stated that the directors would only be legally obliged to consider the issue of solvency if it was believed that the Inland Revenue's view as to the application of extra-statutory concession C9 is correct. CEN stated that the directors of the Paycheck Services Composite Companies would not be guilty of wrongful trading if they continued to trade based on legal advice that extra-statutory concession C9 applies to the Paycheck Services composite company structure. CEN stated that, prior to the structure being set up, Counsel's opinion had been obtained as to whether or not extra-statutory concession C9 does apply to the Paycheck Services composite companies. CEN explained that Counsel had advised that extra-statutory concession C9 does apply. Mr Russell enquired whether or not the Inland Revenue had received a copy of Counsel's Opinion. CEN confirmed that the Inland Revenue has not seen such Opinion".

117. Having taken technical advice, Mr Russell wrote a detailed letter to Neil Myerson dated 25^th June 2004. The net effect was that in relation to "periods prior to telling the company the previous advice was wrong" HMRC stood by "the treatment adopted" on the basis that "the Company could not rely on using a previous mistake forever". For the first time, HMRC placed reliance upon Section 417(3) ICTA 1988. Further, reliance was placed on the argument that "what we have here is an avoidance scheme".
118. On 6^th July 2004, Neil Myerson instructed Mr Ginniff to advise, sending to him detailed instructions setting out the history of the Composite Companies, making reference to the Paycheck Services 2 loans, and the Paycheck Services deficit, and the history of dealings with HMRC. The instructions referred to the fact that, at the meeting on 21^st June 2004, HMRC had indicated that it was prepared to take a pragmatic approach and that "if the structure of the Paycheck Services Companies is no longer operated but is effectively shut-down, then the Inland Revenue will no longer pursue the additional Corporation Tax that they say is payable in respect of some past and current accounting periods". At that stage the current accounting period would have ended on 31^st July 2004.
119. In an Advice dated 21^st July 2004 Mr Ginniff advised in relation to the delays in applying for judicial review, expressing the view that there were better than even chances of persuading the Court to extend time for good reasons. The gist of this Advice was passed on to Mr Holland by Mr Newton on the telephone the same day. Mr Newton's file note records Mr Newton and Mr Holland discussing that because HMRC still wanted to talk about the matter, it was "feasible" that they might change their mind in relation to ESC C9, and that there were two "strands" to that matter, namely an application for permission to apply for judicial review, and carrying on "corresponding with the Inland Revenue in the meantime".
120. Mr Newton spoke to Mr Ginniff on the telephone the following day (22^nd July 2004). Mr Newton's file note of the telephone conversation records that further instructions had been sent to Mr Ginniff to settle proceedings for judicial review, but in the meantime Mr Newton sought Mr Ginniff's "informal view as to the substantive issue with regard to the application or disapplication of ESC C9".
121. In response, Mr Ginniff advised over the telephone that he considered that it was very much worth arguing the position with regard to the application of ESC C9 as it was his view that the structure used by the Composite Companies fell within the wording of ESC C9. He commented that the only argument that HMRC seemed to have was tax avoidance, but that they had not said why it was tax avoidance. As to HMRC's last letter, ie. Mr Russell's letter dated 25^th June 2004, Mr Ginniff is recorded as commenting and believing that it was "a disaster, is not well-drafted, is inconsistent, and ... the author of the letter has no confidence in its contents". The note also recorded Neil Myerson's view that the scheme did not involve tax avoidance because, essentially, the tax take would be less if the scheme did not exist. Unfortunately, neither Mr Ginniff nor Mr Newton had picked up on HMRC's point, made in Mr Russell's letter dated 25^th June 2004 in respect of Section 417(3) ICTA which, if right, plainly took the case outside the scope of ESC C9.
122. Mr Newton reported his conversation with Mr Ginniff to Mr Holland the same day, reporting that Mr Ginniff was "fairly upbeat in regard to the prospects for success …"
123. Mr Ginniff settled draft proceedings for judicial review, but Mr Newton was not happy with them and the decision was taken with Neil Myerson to instruct new Counsel. In Mr Newton's absence on holiday, Mr Conrad McDonnell ("Mr McDonnell") of Grays Inn Tax Chambers was instructed by Mr Tim Norman of Neil Myerson by letter dated 3^rd August 2004. Essentially Mr McDonnell was provided with the materials that Mr Ginniff had been provided with and further more recent documentation, and asked to review Mr Ginniff's advice, settle proceedings for judicial review, and draft a response to Mr Russell's letter dated 25^th June 2004.
124. Mr McDonnell provided an Opinion dated 6^th August 2004 that was, as I understand it, received by Mr Newton on 9^th August 2004, but only after Mr McDonnell had, over the telephone on 6^th August 2004, explained that he thought that the Section 417(3) ICTA 1988 point "blows our claim out of the water".
125. Mr McDonnell's advice could not have provided worse news for the Composite Companies. Mr McDonnell advised in trenchant terms that the Section 417(3) ICTA 1988 point was, indeed, a good point, but also that the case was a plain one of tax avoidance, and further that the existence of numerous "past and present connections" would entitle HMRC not to apply ESC C9. Mr McDonnell in paragraph 32 of his Opinion thus gave "firm advice" to abandon the proposal to bring judicial review proceedings on the basis that there was no real prospect of success and that an attempt should be made to bring the Revenue's enquiry to a close "on the basis of the proposal that they suggested on 21^st June 2004, that is that the structures will be dismantled with no additional tax being assessed for the past accounting period up to 31^st July 2004".
126. Mr McDonnell in paragraph 33 of his Opinion, referred to the fact that the Composite Companies were, by then, within a new accounting period, and expressed the view that HMRC was unlikely to make any concessions in respect of this period, and Mr McDonnell thus "strongly recommended" that the companies "should cease trading or the structure should be substantially revised as soon as practicable lest there be a substantial unbudgeted tax liability for the current accounting period".
127. At paragraph 34 of his Opinion, Mr McDonnell referred to the fact that the additional Corporation Tax liability "would presumably be enough to render some or all the companies insolvent", and referred to the possible personal liability of Mr and Mrs Holland, and, importantly, to the need for "specialist advice".
128. Mr McDonnell further referred to the fact that it would have been possible to ensure that the Composite Companies were not "associated" by giving the "A" voting shares for each company to a different third party, and in paragraph 36 of his Opinion he set out details of alternative structures that he considered would work. At paragraph 37 of his opinion, Mr McDonnell said this:

"As noted, the Revenue apparently now require the structure to be "dismantled". It is not clear whether their effective offer in relation to the periods up to 31^st July 2004 would still stand if, instead of dismantling the structure, the Composite Companies were to move to an arrangement that clearly did not cause them to be "associated" companies, for example under one of the two proposals above. However, it seems to me that it may be possible to persuade the Revenue to accept this, in particular if the structure described in paragraph 36 above is adopted, which would be the most transparent and commercial structure. One argument in favour of this is that the Composite Companies are currently under contract to up to 50 clients in each case and that such contracts cannot simply be discontinued; in some cases there may be contracts for 3 months, 6 months or longer."

129. On 10^th August 2004, Mr McGillivray wrote to the Composite Companies informing them that he intended to enquire into their tax returns for the accounting period ended 31^st July 2003.
130. There is no doubt, in my judgment, that Mr McDonnell's advice came as a considerable shock to Mr Newton, Mr Rees and, most importantly, Mr Holland. On 10^th August 2004, a lengthy telephone conversation took place between Mr Newton and Mr Holland, which Mr Rees later joined, that followed on from telephone conversations between the three of them, and also Mr Norman, the previous day.
131. Mr Newton's file note of the telephone conversation refers to him expressing the view that, subject to "any further comments of Leading Counsel", the application for judicial review should not be pursued, and that Leading Counsel should be asked to advise as to whether the proposed new structure would work.
132. As to the possibility of some sort of deal with HMRC, Mr Newton's file note of the telephone conversation said this:

"CEN stated that his interpretation of what was said by the Inland Revenue Inspectors at the meeting in June was that they would be prepared to forego the additional tax that has been assessed if the Paycheck Composite Companies were closed. CEN stated they should take Leading Counsel's advice on this point. CEN believes that if we write to the Inland Revenue asking them to write off the additional tax that they have assessed on the basis that the Paycheck Composite Companies are prepared to restructure, it is likely they would not agree to change such assessment as it would seem they are looking to dismantle composite company structures.

CEN stated that, from a practical point of view, it would be difficult to restructure each company. However, after discussion, it was determined that we could create new voting shares for each existing Composite Company if Leading Counsel thought there was a possibility that the Inland Revenue would agree to change the additional tax assessments that had been levied.

Peter Rees then entered the room in which Mike Holland was speaking at Paycheck. CEN spoke to Peter Rees and asked Peter what his interpretation was of what was said at the meeting with the Inland Revenue in June with regard to the collection of the additional corporation tax that has been assessed by the Inland Revenue. Peter Rees stated that his interpretation of what was said was that the Inland Revenue would not enforce the collection of additional tax that has been assessed, rather than changing the assessment themselves if the Paycheck companies ceased to trade. Both CEN and Peter Rees agreed that if the Inland Revenue take the position that they are not going to enforce the collection of the additional tax, but it nevertheless stands as a liability, then the companies would be insolvent and would have to discontinue trading anyway. CEN and Peter Rees agreed that the only way the existing Paycheck companies could continue to trade would be if the assessments were actually changed by the Inland Revenue which Peter Rees thought would be extremely unlikely. Peter Rees suggested that 40 new companies should be incorporated straight away as it is likely we are going to have to use new companies with any new structure."

Mr Rees subsequently reminded Mr Newton that the higher rates of tax that might be levied against the Composite Companies could be as much as £30,000 per week.

133. A file note of a subsequent telephone conversation between Mr Holland and Mr Newton on 10^th April 2004 recalls Mr Newton as having explained to Mr Holland that "in view of the latest advice received from Conrad McDonnell of Counsel, Mike is probably now wrongfully trading the Paycheck Composite Companies".
134. The contents of the file note of the telephone conversation on 10^th August 2004 tend to suggest that Mr Newton at least had given up on seeking to challenge the Inland Revenue's approach, and that the focus was on getting a new corporate structure in place that would work from a tax point of view. However, it is clear from Mr Newton's note of a subsequent conversation between Mr Newton, Mr Rees and Mr Holland on 11^th August 2004 that there were concerns that Mr McDonnell and Mr Ginniff had come to a different view, and thus that Leading Counsel's opinion should be sought in the light thereof.
135. This led to detailed instructions being sent to John Tallon QC at Pump Court Tax Chambers, and to a Consultation with Mr Tallon QC on 18^th August 2004. However, in the meantime, on 12^th August 2004, Mr Rees wrote to Mr Newton informing him that "Mike and Lynn have decided" that they want to keep HMRC fully aware of what was going on and would like him to draft a reply to the letter dated 25^th June 2004 as soon as possible. The letter pointed out that even if judicial review proceedings were to be successful, then HMRC intended to amend ESC C9 in any event. Thus it was desired to cease trading the current set up, and to set up a new corporate structure in accordance with Mr McDonnell's advice as soon as possible, in practice not earlier than 1^st October 2004.
136. In his Instructions, Mr Tallon QC was asked to confirm that he agreed with the opinion of Mr McDonnell and, if so, to advise on a strategy to deal with HMRC's assessment of the additional tax. In particular Mr Tallon QC was asked to consider whether HMRC might agree to change the assessment if either the Composite Companies ceased to trade, or offered to restructure so as to "render them as being "non-associated"". The instructions then continued:

"If Leading Counsel is of the opinion that the Inland Revenue would not agree to change such assessments, in the light of comments that have been made by the Inland Revenue at the meeting held on 21^st June (see enclosure 1.28), is Leading Counsel of the opinion that the Revenue might agree not to enforce the collection of such additional tax if the proposals (i) and/or (ii) as outlined above were made? It is Speechleys and Instructing Solicitors' preliminary view, subject to Leading Counsel's advice, that the Inland Revenue want to effectively close composite company structures as they believe that they exist to avoid tax and that accordingly, the Inland Revenue would only agree to an arrangement whereby the Revenue agrees not to collect such additional tax if an offer were made to actually cease to trade the existing Paycheck Services Companies."

137. Mr Tallon QC was further asked to draft a "holding response" to HMRC, and to advise on the alternative structure that it was, by then, proposed to introduce.
138. Mr Tallon QC approved Mr Newton's note of the Consultation on 18^th August 2004. This note records that Mr Tallon QC substantially agreed with Mr McDonnell's opinion albeit that he believed that Mr McDonnell had been "slightly too harsh with regard to his comments concerning tax avoidance". Whilst Mr Tallon QC considered that HMRC had dealt with the association issues "badly", and that leave for judicial review might well be granted, Mr Tallon QC considered that the Composite Companies would "ultimately lose" if an application were made. Further, Mr Tallon advised that the new Corporate Structure suggested by Mr McDonnell was essentially sound and would avoid association issues.
139. However, Mr Tallon QC did advise that HMRC's letter dated 25^th June 2004 should be responded to immediately in the terms of the draft that Mr Tallon QC had settled, and it was agreed at the Consultation that this letter would be sent. Mr Newton's note records that:

"Leading Counsel stated that the best way to take things forward would be to request, as mentioned in Leading Counsel's letter, a meeting with the Inland Revenue with a view to try to do some form of deal with the Inland Revenue with regard to the additional tax that is being chased".

140. Mr Newton's note later recorded the following:-

"Leading Counsel advised that we should inform the Inland Revenue at the next meeting with them that we intend to change the Paycheck structure. After discussing the matter with Leading Counsel, it was decided that new Paycheck Companies would be incorporated in view of the fact that it may take some time to ascertain whether or not a deal can be done with the Inland Revenue with regard to the existing Paycheck Services Companies. Instructing Solicitors pointed out that if the existing Paycheck Services Companies continue to trade, then potentially a liquidator could argue that, since the date of Mr McDonnell's opinion, the Paycheck Services Companies have been wrongfully trading".

The evidence was that Mr Tallon QC made it clear that he was not an insolvency specialist and so could not advise in relation to this latter insolvency issue.

141. In evidence in chief Mr Newton gave evidence of an important conversation between himself and Mr Holland on the train from the Consultation with Mr Tallon QC. This was not mentioned in any of the witness statements and became a matter of some controversy. I shall return to it having dealt with the other events that occurred leading up to the entry of the Composite Companies into administration on 19^th October 2004.
142. On 19^th August 2004 the letter settled by Mr Tallon QC was duly sent to HMRC. On 23^rd August 2004 Speechleys wrote to Neil Myerson referring to the new companies to be incorporated to get in place the proposed new corporate structure with a view to getting the latter up and running by 1^st October 2004.
143. On 25^th August 2004 Mr Rees wrote to Barclays Bank plc referring to the new companies trading from 1^st October 2004, with the old companies trading to 30^th September 2004. The letter, in my view misleadingly, referred to HMRC having "basically given us an amnesty period during which to restructure the company along the lines discussed above". It did concern me that this might affect Mr Rees' general credibility as a witness, but I am satisfied that it does not, and, although not entirely satisfactory, the letter is, perhaps, more readily explicable when read together with Mr Rees's letter of the same day to Neil Myerson in which he said that:

"It seems to be that the best that we can realistically hope for with the Inland Revenue is an "amnesty" with regard to the additional tax due for all periods up to the date of Mr Russell's letter on 25^th June 2004".

144. This letter is an important letter because it went on to refer to the fact that by the end of September 2004, Paycheck Services would have drawn in the order of £150,000 from the Composite Companies, which Mr Rees thought that HMRC might seek to recover so as to render Paycheck Services insolvent. The letter concluded as follows:

"Whilst we both know that Mike does not want to discuss these various scenarios it is obviously an issue that we cannot ignore - I know John Tallon QC will not give a view on this (he made it clear to us he was not an insolvency man) but this is something that you could put past Stephen Conn initially to get his views on the matter".

Stephen Conn ("Mr Conn") is an Insolvency Practitioner in the firm of Begbies Traynor and became one of the joint administrators of the Composite Companies. Mr Newton says that he spoke to him in September 2004 in the circumstances that I refer to below.

145. The new companies were incorporated on 3^rd September 2004.
146. On 10^th September 2004 HMRC (Mr Russell) wrote to Neil Myerson referring to the fact that the enquiry process was complete, that there were no statutory grounds for appeal, thus leaving only "the avenue of judicial review". Mr Russell enquired as to how the Composite Companies intended to proceed.
147. On 20^th September 2004 the shareholders/employees were written to about the new corporate structure. The correspondence is somewhat misleading in that it gives the impression that there was simply to be a change of name, rather than a transfer to new Composite Companies under a new Corporate Structure.
148. On the same day Mr Newton spoke with Mr McGillivray over the telephone with regard to arranging a settlement meeting. This meeting was fixed up and took place on 4^th October 2004. Prior to the meeting that took place, further advice had been received from Mr Tallon QC with regard to the new structure.
149. The meeting on 4^th October 2004 was attended by Mr Newton and Mr Rees on behalf of the Composite Companies and Paycheck Services, and Mr Russell and Mr McGillivray on behalf of HMRC. Mr Russell and Mr McGillivray were informed, seemingly for the first time, about the intention to transfer the business to the new Corporate Structure that did not involve a trust, and was thus not reliant on ESC C9 or any other ESC. Mr Newton proposed that HMRC should accept that ESC C9 did apply to the Composite Companies and Paycheck Services for the time up to the end of October 2004, on the basis that the existing companies would cease to trade from that date, pay all outstanding tax at the lower rate, and thereafter be dissolved. Mr Newton pointed out, amongst other things, that if the Composite Companies were forced to cease trading, and enter some form of insolvency process, then the pot available for HMRC would be reduced given the costs involved (said to be typically £5,000 to £6,000 per company), as well as claims for breach of contract that it was said would otherwise arise.
150. Mr Newton's proposal was not accepted, as Mr Russell confirmed in a letter dated 5^th October 2004 to Neil Myerson that made it clear that HMRC still sought the additional (HRCT) Corporation Tax dating back to 2002 when HMRC (Mr Williams) had advised that ESC C9 did not apply. The letter flagged up that HMRC considered that unlawful dividends had been paid.
151. The letter dated 5^th October 2004 was only received by Neil Myerson on 13^th October 2004, and was immediately forwarded to Mr Holland. Mr Newton then spoke on the telephone to Mr Holland and Mr Rees. Mr Newton expressed the view that the directors should act in the best interests of creditors and that the position had changed from the previous week as there was "no possibility of doing a deal with IR" to quote from Mr Newton's attendance note. Mr Newton thus advised that no further dividends should now be declared as there were no "distributable reserves". It was thus concluded that there could not be any further delay in moving to the new structure and causing the existing companies to cease to trade. The drafting of an agreement to effect the transfer of the business to the new structure was discussed. Mr Conn was contacted on the same day.
152. On 19^th October 2004 Mr Conn and Paul Stanley ("Mr Stanley") were appointed by the respective companies as joint administrators. Shortly thereafter the various contracts of the existing Composite Companies were transferred to the new companies thereby avoiding any liability for breach of contract. The net effect was that HMRC was the only creditor of the Composite Companies, in respect of the claim to HRCT.
153. I revert now to consider the matters discussed on the train from London to Crewe on 18^th August 2004. Before doing so it should be noted that in paragraph 40(1) of Mr Holland's Defence it is alleged that a successful application for judicial review would have "reduce[d] the alleged liabilities of [the Composite Companies] and thus substantially improve[d] their respective financial positions". Further, in paragraph 40(2) it was alleged that if the Composite Companies stopped paying dividends, then it would lose the shareholders/employees, and that this would put it in breach of the contract with the customers for whom they worked, thus exposing the Composite Companies to damages.
154. These points were touched upon in general terms in paragraphs 12 and 13 of Mr Holland's second witness statement dated 14^th April 2008, made only two days before the trial began, but they were not developed in evidence in chief or expressly challenged in cross-examination.
155. However, when Mr Newton subsequently came to give evidence in chief, in answer to questions put by Mr Knox QC, he gave extensive evidence, not covered by any witness statement, as to a conversation on the train to Crewe on 18^th August 2004 following the Consultation with Mr Tallon QC. In essence it was Mr Newton's evidence that, on the train and in the light of Mr Tallon QC's advice, he advised that Mr and Mrs Holland might be wrongfully trading. He said that he considered that Mr Holland was "between the devil and the deep blue sea at that point". His evidence continued as follows:

"A. … In terms of wrongful trading, I basically explained that he shouldn't continue to run the company unless there is a reasonable prospect of avoiding insolvent liquidation.

In the current scenario I advised there may be an argument that technically dividends being paid at that time may be unlawful, but that needed to be balanced against the need to also mitigate in the interest of the creditors, to mitigate (a) the amount of creditors, and also whether or not a deal could be done with the Revenue.

So I basically - I said if there was a reason - I explained to Mr Holland he would have to justify why he continued the current operation. It was recognised that if the companies were closed at that point, then a large number of creditors would be created in terms of clients to whom services were being provided for. There would undoubtedly be breaches of contract, because men would not go to work for people if they were not paid. So this was an issue.

Also the employees - bearing in mind there were no secured creditors, the employees, if they were not paid - because all the contractors were employees, would be preferential creditors; which would rank above and beyond the Inland Revenue.

So on the one side there was a decision that if the company stopped to trade, then loads of creditors would be created, insolvency fees would be incurred.

On the other side there was a prospect - and a real prospect, I felt, at that time - of doing a deal with the Revenue. And Mr Holland had to weigh up in terms of making a decision whether to continue or not, those issues.

Q. As far as you could see at the time, did you advise him that it was in the best interests of the companies, in your view, to stop trading immediately?

A. No, I felt it was a decision to be made by Mr Holland. Going back to the meeting with the Revenue on 21^st June, Mr Russell had made it clear that the Revenue would take a pragmatic approach - that was his words - particularly if the Paycheck - then Paycheck companies were to cease trading.

We discussed that at the meeting with Mr Tallon, and we had effectively decided to create a series - indeed before that date, create a series of new companies, and therefore the existing companies would cease trading. So, based on what Mr Russell had said at the meeting in June 2004, we felt there was every prospect - well, there was a reasonable prospect that the Revenue might do a deal, and accept a lower amount of tax, because that - they at that time were potentially the only creditor, and that would be in their best interests commercially.

Q. When you say "do a deal and accept less tax", what sort of deal?

A. They would simply accept that, without creating a precedent, on the basis that the Paycheck - the Paycheck Companies in issue would stop trading, the lower amount of tax at 19 per cent, up to the date they ceased trading. I think we said at the end of October. Mr Russell had indicated that they would take a pragmatic approach, and Mr Tallon advised that we should pursue that avenue. I felt that if the Revenue accepted that, then all the insolvency practitioner's fees would be saved, and that creditors, some of which would have ranked higher than the Revenue in a winding up or administration, would be created".

156. I challenged Mr Knox QC as to why this evidence had only come out in this way, and he candidly referred to the financial constraints that Mr and Mrs Holland had been under preparing for trial, and that he only discovered about the conversation on the train when taking instructions from Mr Newton whilst Mr Holland was in the witness box. This explains why, when re-examining Mr Holland, Mr Knox QC asked Mr Holland if he could recall a discussion on the train to Crewe, only to be given the unhelpful answer that Mr Holland could not recall the same.
157. Mr Rees in evidence in chief, did recall the conversation on the train. He recalls Mr Holland being "very uptight and stressed out over the whole thing", following the Consultation with Mr Tallon QC, and Mr Newton starting to talk about "insolvency issues". Mr Rees recalled Mr Newton pointing out that it was necessary to consider the position of the creditors as well as HMRC, and "bandying about" figures such as the cost of liquidation, as well as discussion about contractual liabilities of "say £2,000 or more", in respect of the "contractual position of the employees of the Composite Companies". Mr Rees then graphically described how Mr Holland left the discussion, and went and sat elsewhere on the train indicating as he did so, in graphic language that his head was swimming and that he was "fed up of your fucking scenarios".
158. Mr Rees was asked whether he recalls Mr Holland being asked to stop trading to which he replied:

"A. I don't specifically recall that being said but I recall Carl, you know, I recall, you know, Carl and I certainly discussed the question of, you know, he should certainly stop paying dividends or, you know, seriously consider his position at this time. Now, I don't know whether that was before or after Mike had left us."

159. Despite the circumstances in which the relevant evidence emerged, I am satisfied that a conversation did take place on the train on return from London on 18^th August 2004 broadly along the lines described by Mr Newton in which Mr Newton did seek to raise with Mr Holland the fact that he and Mrs Holland might be wrongfully trading, that trading should not continue if there was no reasonable prospect of avoiding insolvent liquidation, and that there might be an argument that the continuing to pay dividends might be "technically" unlawful, but that Mr Holland needed to balance the various considerations including the prospects of doing a deal with HMRC, and the fact that other creditors would be created if trading were simply to cease.
160. However, it is to my mind clear from Mr Rees' evidence that Mr Holland was not, for understandable reasons in the circumstances, in any mood to properly engage in the discussion that Mr Newton had initiated. I consider that this probably explains why Mr Holland had no recollection of the conversation, why Mr Newton did not follow his usual procedure of making a careful file note of the conversation, and why the conversation was not dealt with in the witness statements.
161. Further, there is no suggestion that Mr Newton attempted to repeat the advice given on the train, for example by a follow up letter.
162. In addition I remind myself of the final paragraph of Mr Rees' letter to Neil Myerson dated 25^th August 2005 recording that "Mike does not want to discuss the various scenarios". It was unclear from the evidence as to whether this simply related to Mr Holland's attitude on the train back from seeing Mr Tallon QC. However, there is no evidence, following the train journey, of either Mr Newton or Mr Rees having given, or of Mr Holland having sought, further advice as to the propriety of continuing to pay dividends.
163. Mr Newton did suggest that he spoke to Mr Conn in September 2004 and that Mr Conn had endorsed the approach being taken. However, there is no note of any such conversation, and I consider it more likely that the relevant conversation took place somewhat later in the day when Mr Conn was approached in relation to putting the Composite Companies into administration when Mr Conn may have commented on the position of Mr and Mrs Holland by reference to what he was told, otherwise I would have expected Mr Newton to have made a file note of the conversation and of a subsequent conversation passing on the advice to Mr Holland.

I Were Mr and/or Mrs Holland De Facto Directors of the Composite Companies?

(i) Introduction

164. Mr and Mrs Holland were not de jure directors of the Composite Companies, but they were both de jure directors of the Composite Companies' de jure director, Paycheck Directors.
165. Section 212 IA 1986 permits proceedings against a person "who is or has been an officer" of a company. Section 744 CA 1985, which is incorporated into IA 1986 by Section 251 thereof, provides that an "officer" includes "a director, manager or secretary". Section 251 IA 1986 provides that "director" includes "any person occupying the position of director by whatever name called", ie. what is commonly called a "de facto director". It is HMRC's case that Mr and Mrs Holland were both de facto directors of the Composite Companies.
166. It is accepted on behalf of Mr Holland, but not Mrs Holland, that his actions in relation to the Composite Companies were sufficient to render him a de facto director, subject to the point made on behalf of Mr and Mrs Holland that their actions, if otherwise sufficient to make them de facto directors, were, on proper analysis, carried out as agent on behalf of Paycheck Directors such that it is not permissible to treat them as de facto directors unless it is possible to pierce the corporate veil. I shall refer to this as the "corporate veil point".
167. It is further contended on behalf of Mrs Holland that her actions were not, in any event, sufficient to constitute her as a de facto director.
168. I first set out the general principles of law involved in deciding whether a person is a de facto director. I then consider the corporate veil point, and, finally, consider the position of Mrs Holland.

(ii) General Principles

169. The law as to what constitutes a de facto director has largely developed in the context of decisions relating to applications under the Company Directors Disqualification Act 1986. The following propositions (adapted from Re Gemma Limited [2008] EWHC 546 at [40] per Jonathan Gaunt QC) appear from the cases:

169.1 It is necessary to plead and prove that the person alleged to be a de facto director undertook functions in relation to a company that could only properly be discharged by a director - Re Hydrodam (Corby) Limited [1994] 2 BCLC 180 at 183 per Millett J.

169.2 It is not necessary that the person in question is held out as a director, although on the facts of a particular case, holding out might point to the fact that the person acted as a director in fact - Secretary of State for Trade & Industry v. Hollier [2007] BCC 11 at 23H - 24A, per Etherton J, applying Secretary of State for Trade & Industry v. Tjolle [1998] 1 BCLC 324 at 343 - 344.

169.3 What matters is not what the person is called, but what he does - Re Mea Corporation [2007] 1 BCLC 618 at 637e, per Lewison J.

169.4 It is necessary for the person alleged to be a de facto director to have participated in directing the affairs of the company on an equal footing with the other director(s) and not in a subordinate role - Hollier - at 24 B - H, applying and explaining Re Richborough Furniture Limited [1996] 1 BCLC 507 at 524, per Timothy Lloyd QC.

169.5 The person in question must be shown to have assumed the status and functions of a company director and to have exercised "real influence" in the corporate governance of the company - Re Kaytech International plc [1999] 2 BCLC 351 at 424c.

169.6 If it is unclear whether the acts of the person in question are referable to an assumed directorship or some other capacity (such as shareholder), the person in question is entitled to the benefit of the doubt, but the Court must be careful not to strain the facts of the case in deference to this observation - Re Richborough (supra) at 524 and Kaytech (supra) at 423a - b.

(iii) Corporate Veil Point

170. The point advanced by Mr Knox QC on behalf of Mr Holland, with the support of Mr Casey on behalf of Mrs Holland, is that the actions of Mr Holland, and if appropriate Mrs Holland, in directing the affairs of the Composite Companies, including in particular declaring dividends, were done as director(s) of Paycheck Directors and as agent(s) of the latter company, and that if any liability arises for breach of director's duty, then that is a liability of Paycheck Directors, and not the directors thereof and that to find otherwise would involve piercing the corporate veil, and usurping the principles going back to Salomon v. A. Salomn & Co. Ltd [1897] AC 22 that directors and/or shareholders are not, without more, responsible for the liabilities of their company. Mr Knox QC referred me to various passages in Salomon v. Salomon including Lord Herschell at 43 and Lord Davey at 56 - 57.
171. Mr Knox QC also referred me to Kensington International Limited v. Republic of Congo [2006] 2 BCLC 296 as authority as to the circumstances in which the Court might be prepared to pierce the corporate veil, namely where transactions or structures which were purely a sham and a façade and had no legal substance were set up with the intention of defeating claims of creditors against the entity responsible for setting up the transactions or structures and which lay behind them. Subject to that the Court is required to recognise and respect the separate legal personality of a corporate entity, and the separate personality of the company could not be ignored merely because the Court considered that it might be just to do so - see Cooke J at [177] - [190].
172. Mr Knox points out that no such allegation of pure sham or façade is made in the present case in relation to Paycheck Directors, and nor is it asserted that Mr (or Mrs) Holland acted outside his (or her) authority as a director of Paycheck Directors in directing the affairs of the Composite Companies.
173. In Hydrodam (supra) at 184a - b, Millett J expressly rejected the submission of the Liquidator that where a body corporate is a director of a company, its own directors must, ipso facto, be shadow directors of the company. Millett J observed that attendance at Board meetings and voting with others might, in certain limited circumstances expose a director to personal liability to the company of which he is a director or its creditors, but that it does not, without more, constitute him a director of any company of which his company is a director.
174. In Secretary of State for Trade & Industry v. Hall and Nuttall [2006] EWHC 1995 one of the respondents to disqualification proceedings, a Mr Nuttall, was a director of a corporate director of the subject company, and it was alleged against him that he was to be treated as a de facto director of the subject company. However, the allegation was that the corporate director, through Mr Nuttall, had failed to play a sufficiently active part in the running of the subject company.
175. At paragraph 16, Evans-Lombe J posed the question as to whether it was open to the Court to "pierce the corporate veil" and treat Mr Nuttall as a director of the subject company. On the facts, because Mr Nuttall had not been active in directing the affairs of the subject company, Evans-Lombe J held that the necessary criterion to satisfy the test was not fulfilled without having to go into any corporate veil issues. However, at paragraph 30(iii), Evans-Lombe J said this:

"It seems to me that in order to be constituted a de facto director of a subject company, a director of a corporate de jure director must cause the corporate director to take actions with relation to the subject company as would have constituted it a de facto director of that company were it not already a director de jure".

176. Applying Evans-Lombe J's test would, as I see it, clearly lead to the conclusion that Mr Holland at least was a de facto director of the Composite Companies in that he, insofar as he is properly to be regarded as having acted on behalf of Paycheck Directors, clearly caused it to act in such a way as would have caused the latter to be treated as a de facto director were it not already a de jure director. In saying this, I am conscious that Evans-Lombe J did not in terms address the corporate veil point or issues in relation to separate legal personality.
177. However, I am not persuaded that arguments as to separate legal personality assist or are strictly relevant to the issue. Section 251 IA 1986 raises what is essentially a question of fact as to whether Mr (or Mrs) Holland were "occupying the position of director [of the Composite Companies] by whatever name called". As a matter of fact Mr Holland (if not Mrs Holland) did, by what he actually did, direct the affairs of the Composite Companies and assume the functions of a director albeit not holding himself out as such. Whether he strictly purported to do so on his own account or as agent for Paycheck Directors is, to my mind, beside the point. This question of fact is as I see it, a very different one from that involved in considering whether a mere agent is personally responsible for the liabilities of a limited company, in which case liability is likely to depend on demonstrating that the transaction or corporate structure is a sham or façade.
178. I would add that I do not consider that the observations of Timothy Lloyd QC (as he then was) in Richborough at 524 as to acting in some other capacity assist Mr (or Mrs) Holland on this point. These observations are, as I see it, directed at distinguishing between the quality of acts, eg. acting as a shareholder or consultant rather than as a director, rather than the present question as to whether it matters that Mr (and/or Mrs) Holland, albeit director(s) of Paycheck Directors, were also acting as a director(s) of the Composite Companies.
179. Consequently, I do not consider that the corporate veil point prevents me from finding that either Mr or Mrs Holland was a de facto director of the Composite Companies. As this was the only point taken on behalf of Mr Holland, it necessarily follows that I find that he was a de facto director of the Composite Companies.

(iv) Mrs Holland

180. Apart from the fact that Mrs Holland was a de jure director of Paycheck Services, Paycheck Directors and Paycheck Secretarial, Mr Green's submissions on behalf of HMRC as to Mrs Holland's involvement in the running of the Composite Companies focussed upon:

180.1 The fact that she was described on the website as part of the team running the "Paycheck" business;

180.2 What he suggested was her equal involvement in the process of declaring dividends;

180.3 The fact that she signed cheques;

180.4 The fact that she was present at the meeting on 24^th February 2004; and

180.5 That Speechleys' letter dated 12^th August 2004 referred to the fact that "Mike and Lynn have decided …".

181. Mrs Holland frankly accepted that the business was a joint enterprise, but I accept her evidence when she said that:

"… It was my husband's idea and I agreed to help with the office side of things …"

"… I took care of the office matters and Mike took care of everything else."

Further, when asked whether she was concerned as to her own personal position, she said that she was not concerned at all and that;

"… I trusted my husband and his advisors"

182. As to the matters specifically relied upon by HMRC, whilst it is certainly correct that Mrs Holland was described on the website as part of the team running the "Paycheck" business, this, to my mind, adds nothing to the fact that Mrs Holland was a de jure director of the companies that she was a de jure director of, including Paycheck Services, and a 50% shareholder in Paycheck Services. In order to have become a de facto director of the Composite Companies, then, on the authorities, it would be necessary for me to find that she had, as a matter of fact, played an active part in directing the affairs of the Composite Companies in the sense of exercising "real influence" in the corporate governance thereof on much the same basis as Mr Holland. I am quite satisfied that she did not.
183. In no sense could it, in my judgment, properly be said that decisions were taken jointly between Mr and Mrs Holland. Mrs Holland's role was consistent with acting as office manager, shareholder and dutiful wife rather than as director of the Composite Companies - cf. Re Red Label Fashions Limited [1999] BCC 308, at 313 per Lightman J.
184. Whilst Mrs Holland ran the office and input details into the computer that led to the production of the dividend resolutions, this was, once the system was set up, a matter of performing routine functions rather than making an executive decision each time a dividend was paid. In any event, those actions are entirely consistent with her role as a director of, and shareholder in Paycheck Services, whose function was to administer the systems.
185. As to the resolutions themselves, Mrs Holland did not, as I see it, play any part in any executive decision made on behalf of the Composite Companies to pay dividends and to continue to pay the same. Further, it is perhaps not without significance that the relevant resolutions of the Composite Companies refer to the sole director thereof, namely Paycheck Directors, as being represented by Mr Holland.
186. The signing of cheques, even where, as at least in one instance in the present case, the relevant signature appears above the word "director", is not conclusive, and ought not to give rise to a finding that the cheque signatory is a de facto director where the signing of the cheques was, as it plainly was in the present case, a clerical task involving no real decision making on behalf of the company making payment by the cheque - see Re Gemma Limited (supra) at [44] and [49]. The circumstances in which Mrs Holland came to sign cheques referring, on the face thereof, to "director" were amply explained by Mrs Holland in her evidence in chief, and I thus disregard the signing of the cheques as a significant factor.
187. I have already found that Mrs Holland's presence at the meeting on 24^th February 2004 was simply down to Mr Holland inviting her to attend as they were planning to go out for dinner afterwards, and that she played no active part in the meeting. It is, in my judgment, highly significant that this was the only meeting that she is recorded as having attended or participated in.
188. As to Speechleys' letter dated 12^th August 2004, I consider that the reference to "Mike and Lynn deciding" simply reflected the fact that the business belonged to the two of them, and that Mr Holland made the decision on behalf of himself and Mrs Holland. Asked about this letter, Mr Rees replied:

"I know it says "Mike and Lynn" but as I've … previously told you, the situation is that they sit across the desk in the office, Mr Holland this side, Mrs Holland that side … and every conversation that I have had was with Mr Holland. Mrs Holland was present, but she never participated".

189. Consequently, I do not find it established on the evidence that Mrs Holland was a de facto director of any of the Composite Companies.

J Lawfulness of Dividends - Liability of Directors

(i) Statutory Provisions

190. Mr Holland accepted in evidence that he was, at all relevant times, aware that a company could only properly pay dividends out of profits. Dividends may, indeed, only be paid out of profits - or rather profits available for distribution determined in accordance with the provisions of Part VIII of CA 1985, which despite the enactment of the Companies Act 2006, continues to apply to distributions made prior to 6^th April 2008, and provides, so far as is relevant, as follows:

"263. - Certain distributions prohibited.

(1) A company shall not make a distribution except out of profits available for the purpose.

…

(3) For the purposes of this Part, a company's profits available for distribution are its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made.

270. - Distribution to be justified by reference to company's accounts.

(1) This section and sections 271 to 276 below are for determining the question whether a distribution may be made by a company without contravening sections 263, 264 or 265.

(2) The amount of a distribution which may be made is determined by reference to the following items as stated in the company's accounts-

(a) profits, losses, assets and liabilities,

(b) provisions of any of the kinds mentioned in paragraphs 88 and 89 of Schedule 4 (depreciation, diminution in value of assets, retentions to meet liabilities, etc.), and

(c) share capital and reserves (including undistributable reserves).

(3) Except in a case falling within the next subsection, the company's accounts which are relevant for this purpose are its last annual accounts, that is to say those prepared under Part VII which were laid in respect of the last preceding accounting reference period in respect of which accounts so prepared were laid; and for this purpose accounts are laid if section 241(1) has been complied with in relation to them.

(4) In the following two cases -

(a) where the distribution would be found to contravene the relevant section if reference were made only to the company's last annual accounts, or

(b) where the distribution is proposed to be declared during the company's first accounting reference period, or before any accounts are laid in respect of that period,

the accounts relevant under this section (called "interim accounts" in the first case, and "initial accounts" in the second) are those necessary to enable a reasonable judgment to be made as to the amounts of the items mentioned in subsection (2) above.

(5) The relevant section is treated as contravened in the case of a distribution unless the statutory requirements about the relevant accounts (that is, the requirements of this and the following three sections, as and where applicable) are complied with in relation to that distribution.

…

277. - Consequences of unlawful distribution.

(1) Where a distribution, or part of one, made by a company to one of its members is made in contravention of this Part and, at the time of the distribution, he knows or has reasonable grounds for believing that it is so made, he is liable to repay it (or that part of it, as the case may be) to the company or (in the case of a distribution made otherwise than in cash) to pay the company a sum equal to the value of the distribution (or part) at that time."

Paragraph 89 of Schedule 4 to CA 1985 provides that:

"References to [provisions for liabilities] are to any amount retained as reasonably necessary for the purpose of providing for any liability [the nature of which is clearly defined and] which is either likely to be incurred, or certain to be incurred but uncertain as to amount or as to the date on which it will arise".

(ii) The Rival Arguments

191. On behalf of HMRC, Mr Green argued that:

191.1 No dividends ought to have been paid by any of the Composite Companies at any time, in that they ought, at all times to have provided for HRCT. The requirement to make provision for liabilities being based upon the actual facts of the situation with the benefit of hindsight, rather than upon the facts as they might reasonably have been perceived at the time the dividends were paid. Consequently, as it is now accepted that Section 417(3) ICTA 1988 meant that ESC C9 could not apply, irrespective of "past or present connection" and "tax avoidance" issues, it can now be seen that provision ought to have been made, and so the dividends were unlawful.

191.2 If an unlawful dividend is paid, then that amounts to the making of an ultra vires payment that the directors responsible for the payment are, as a matter of strict liability, bound to restore.. As to this strict liability, Mr Green relies upon Bairstow v. Queens Moathouse plc [2000] 1 BCLC 549 at 545 - 546, per Robert Walker LJ, applying Re Exchange Banking, Flitcroft's Case [1882] 21 Ch D 519, and Re Loquitur, IRC v. Richmond [2003] 2 BCLC 442 at 471 - 472 per Etherton J, applying Re Lands Allotment Common Company [1894] 1 Ch 616 at 638, as well as Flitcroft's Case (supra), Re Sharpe [1892] 1 Ch 184, Selangor United Brother Estates Limited v. Craddock (No.3) [1968] 1 WLR 1555, at 1575, and Belmont Finance Corp v. Williams Furniture (No.2) [1980] 1 All ER 393 at 404.

191.3 Consequently Mr and Mrs Holland, as de facto directors are liable to restore all the dividends paid, subject only to the statutory defence under Section 727 CA 1985, which HMRC accept should be applied to relieve Mr and Mrs Holland up to Mr Williams' letter of 24^th April 2002, but not thereafter.

191.4 In any event, even if the dividends were lawful, Mr and Mrs Holland acted in breach of their duties to act with reasonable skill and care as de facto directors by causing the dividends to be paid so as to leave the Composite Companies insolvent.

192. On behalf of Mr and Mrs Holland, Mr Knox QC and Mr Casey argued that:

192.1 The requirement to make provision for liabilities, and hence the lawfulness of any dividend made without making provision for the relevant liability, depends not upon the actual facts as now known with the benefit of hindsight, but the upon the facts as reasonably perceived at the time. In the present case the facts as reasonably perceived by Mr and Mrs Holland did not require the making of provision until comparatively late in the day.

192.2 There is no strict liability upon directors to restore unlawful dividends for which they are responsible, and directors will not be liable if they had reasonably believed that the dividend could lawfully be paid. Mr Knox QC, with the support of Mr Casey, relied on a line of authorities including in Re County Marine (Rance's Case) [1870] 6 LR Ch App 104, at 118 (per Sir William James) and 122 (per Sir G Mellish), Re Kingston Cotton Mill Company (No. 2) [1896] 1 Ch 331 at 345 - 348, per Vaughan Williams J, Dovey v. Cory [1901] App Cas 477, and The City Equitable Fire Insurance Co Limited [1925] 1 Ch 407, at 426 per Romer J. Mr Knox QC relies upon the fact that this line of authority is referred to with apparent approval by Buckley on the Companies Acts, see T [A70.151] - T [A70.160], and T [A70.164]. Mr Casey relies on a passage in Gore-Browne on Companies at 16[1] to the effect that: "a director is answerable as a trustee for any misapplication of the company's property in which he participated and which he knew or ought to have known to be a misapplication".

192.3 Mr and Mrs Holland reasonably believed that the dividends could lawfully be paid until comparatively late in the day.

192.4 Even if the stage was reached when the dividends were unlawful and/or Mr or Mrs Holland became liable in respect thereof, the Court should use its discretionary powers under Section 727 to relieve Mr and Mrs Holland from liability for the whole of the relevant period, ie up to the time that the Composite Companies ceased to trade.

192.5 Further and in any event, Target Holdings Ltd v. Redferns [1996] AC 421, is authority for the proposition that the onus is on HMRC to prove that the Composite Companies suffered loss as a result of any breach of duty by Mr or Mrs Holland. On proper analysis the Composite Companies suffered no loss. Rather, if the Composite Companies had stopped paying dividends before the new structure was in place, then trading would have ceased, giving rise to contractual liabilities to shareholders/employees and those to whom the latter were contracted that have, in fact, been avoided.

(iii) Preliminary Observations

193. As is apparent from the above analysis of the background, issues arose during the history of the Composite Companies, as to loans made by the Composite Companies to Paycheck Services 2 and in relation to liabilities incurred to the Composite Companies that Mr Rees had initially regarded as monies that had been "borrowed" by Paycheck Services but which were later treated as a deficit. Arguably these are matters that might have been relevant to the lawfulness of dividends and the "items" specified within Section 270(1) CA 1985 to which regard is required to be had in determining profits available for distribution. However, HMRC's pleaded case is confined to the alleged failure to make provision in respect of HRCT, and Mr Green correctly accepted that these matters are relevant only to the exercise of discretion under Section 727 CA 1985. In any event, it does seem to me that very much further disclosure of documentation as to the Composite Companies' financial position would have been required, as well as fuller enquiry into the point before I could properly have made any finding of unlawfulness of dividends based on these matters.
194. Further, the point was mooted in opening by Mr Green that the mini-profit and loss accounts were, in themselves, not accounts of a kind that enabled a "reasonable judgment to be made" within the meaning of Section 270(4) CA 1985. Mr Knox QC, when this was raised, took a pleading point that no such allegation had been raised in the Particulars of Claim by way of challenge to the dividends, HMRC's case resting solely upon whether proper provision had been made for HRCT without a more general complaint as to the adequacy of the financial information upon which any decision to pay dividends had been based. None of the mini-profit and loss accounts have been produced for the purposes of the trial and given Mr Knox QC's objection in opening there has been no real examination of the issue, although as I have mentioned, Mr Rees did observe that the mini-profit and loss accounts were probably a more useful guide as to profits available for distribution than management accounts. However, not being a live issue upon which the dividends are challenged, I do not need to make any findings thereupon.
195. There is a further potential point as to whether the dividends were ever lawfully approved in accordance with Article 8(6) of the Composite Companies' Articles of Association, and/or Articles 102 and 103 of Table A given the automated way in which dividend "resolutions" were produced. However, again, this does not form part of HMRC's pleaded case, and there was no investigation of the issue at trial. Consequently, I do not consider it appropriate to make any findings as to the lawfulness or otherwise of the dividends based thereupon.

(iv) Provision for Liabilities "Likely to be Incurred"

196. Where, as in the present case, the Composite Companies' last annual accounts plainly did not disclose profit available for distribution, it was necessary in accordance with Sections 270(3) and (4) CA 1985 that any distribution be limited to profits available for distribution as determined "by reference to" accounts that "enabled a reasonable judgment to be made" as to amounts of the items referred to in Section 270(2) CA 1985, including provisions of the kind referred to in paragraph 89 of Schedule 4 to CA 1985. The effective complaint in the present case is that the dividends in question were paid without making provision for HRCT.
197. I consider that the references in Section 270(4) and paragraph 89 of Schedule 4 to "reasonable judgment" and to "reasonably necessary" point against an intention to render a dividend unlawful if it is only with hindsight that it can properly be said that provision ought to have been made for a particular liability. In my judgment, what the relevant provisions require is the making of a reasonable judgment based on facts as reasonably perceived, or that would have been ascertained by reasonable enquiry. Thus, for example, if there was no reasonable means of knowing that a debt was a bad debt (eg. because it was reasonably not known that the debtor was insolvent) then it does not seem to me that the relevant provisions intended to, or did in fact provide, that a dividend paid in these circumstances was unlawful. However, the necessary consequence of Mr Green's argument is that it would be.
198. Further, in relation to liabilities of the kind specified in paragraph 89 of Schedule 4 to CA 1985, I consider that, based on the language thereof read together with that of Section 270(4) CA 1985, there is only a requirement to make provision for the purposes of the "interim accounts" if, on a reasonably objective view of the facts as known or reasonably ascertainable by those taking the decision to pay the dividend, the liability is likely (in the sense of being more likely than not) to be incurred.
199. In opening Mr Green, on behalf of HMRC, accepted that the appropriate definition of "likely" in paragraph 89 of Schedule 4 was more likely than not, and I consider that must be right. A definition based on, say, a "reasonable prospect" of the relevant liability arising would, as I see it, produce a level of uncertainty that the legislation could not sensibly have intended.

(v) Strict Liability?

200. The question then arises as to whether, if a dividend is held to be unlawful, the directors responsible are liable as a matter of strict liability to make good the unlawful dividend paid away, or at least compensate the company for any loss occasioned thereby.
201. Mr Knox QC submits no, and that the line of authorities referred to in paragraph 192.2 above is reflected in the following passage from the judgment of Vaughan Williams J in Re Kingston Cotton Mill Company (No.2) (supra) at 347 - 348 where, after referring to Flitcroft's Case and to general principle the directors will be liable to restore unlawful dividends that they have approved, and to other cases, he said this:

"On the whole I have come to the conclusion that there is no such bulk of authority as binds me to hold that directors who pay away the funds of the company under an honest and reasonable belief in a state of affairs which would justify the payments made be held liable to replace the funds because it turns out on the true facts that the payments were ultra vires."

202. Buckley on the Companies Acts at T[A70.164] refers to this passage and comments, by reference to Bairstow v. Queens Moat Houses plc at first instance ([2000] 1 BCLC 549, per Nelson J), that:

"Honesty would not now be considered sufficient, however, if the director ought to have known, as a reasonably competent and diligent director, that the payment was unlawful".

This reflects the fact that a stricter view is now taken of what a director ought reasonably to know about the Company's affairs. In this respect mere honesty will not prevent liability - cf. Buckley (supra) at T[A70.151] - T[A70.160].

203. In Bairstow at first instance Nelson J at 557 referred to the principle in Flitcroft's Case (supra) and also to Selangor United Rubber Limited v. Craddock (No. 3) (supra) and Re Sharpe (supra), and cited Lindley LJ in the latter case at 165 when he had said:

"As soon as the conclusion is arrived at that the company's money has been applied by the directors for the payments which the company cannot sanction, it follows that the directors are liable to replace the monies, however honestly they may have acted."

However, Nelson J went on to say, by reference to the cases relied on by Mr Knox QC including Re Kingston Cotton Mill Company (No.2) (supra) that:

"No repayment of an improperly paid dividend will however be ordered where the payment was made without fault on the part of the directors".

He concluded at page 559 by finding that a director who authorised payment of an unlawful dividend in breach of his duty as a quasi trustee would be liable to repay the same if:

203.1 He knew that the dividend was unlawful, whether or not that actual knowledge amounted to fraud;

203.2 He knew the facts that established the impropriety of the payments even though he was unaware that such impropriety rendered the payment unlawful (Re Kingston Cotton Mill (No.3) (supra) at 347 and Precision Dippings Limited v. Precision Dippings Marketing Limited [1986] Ch 447 at 457;

203.3 He must be taken in all the circumstances to know all the facts which rendered the payments unlawful (Precision Dippings (supra) at 457); and

203.4 He ought to have known, as a reasonably competent and diligent director, that the payments were unlawful (Re D'Jan of London Limited [1994] 1 BCLC 561).

On the facts, Nelson J held that, subject to a Section 727 CA 1985 defence in respect of certain of the payments, the directors were liable to repay the dividends on the basis that they had been at fault to the extent of falling within one or more of the categories referred to above.

204. On appeal the real issue was as to whether or not the principle in Flitcroft's Case applied only in the case of an insolvent company, where the payment of an unlawful dividend directly prejudiced the interests of the company's creditors, and the Court of Appeal held that it was not so limited. The Court of Appeal thus did not review Nelson J's consideration of the authorities, nor his conclusion at page 559 referred to in paragraph 203 above.
205. However, at 554 - 555, Robert Walker LJ, by reference to Precision Dippings (supra) at 455 and 457, made reference to the strict and mandatory character of Section 270 CA 1985, and to the fact that the Court of Appeal had in the latter case confirmed that directors are accountable to the company for unlawful dividends paid in contravention of Part VIII CA 1985, whether or not the dividends are demonstrably paid out of capital, although, in fact, the actual decision of the Court of Appeal in Precision Dippings related to a claim against a shareholder who had received the dividend.
206. At page 546 [44], Robert Walker LJ said this:

"[44] In my judgment the point must be decided by reference to principle rather than authority. Queens Moat's case is founded on the fundamental proposition (which was affirmed by the House of Lords in Salomon v. Salomon & Co Limited [1897] AC 22, [1895-99] All ER Rep 9 and which Cotton LJ had well in mind in Flitcroft's Case) that a corporation is a legal person separate from the persons who are from time to time its members (in the case of a company limited by shares, the shareholders). The basic rules about lawful and unlawful dividends, developed from the earliest days of company law and now elaborated in accordance with Community legislation, exist not only for the protection of creditors but also for the protection of shareholders. If directors cause a company to pay a dividend which is ultra vires and unlawful because it infringes these rules, the fact that the company is still solvent should not be a defence to a claim against the directors to make good the unlawful distribution."

207. Re Loquitur Limited, IRC v. Richmond [2005] 2 BCLC 442 was a case that concerned a similar issue to the present, namely whether provision ought to have been made prior to paying a dividend for capital gains tax ("CGT") due as a result of a rollover scheme not being successful. It was a feature of that case that if the rollover scheme had been successful then the company would have been liable to pay a success fee of £1m. Consequently, the company was certainly liable for either CGT or the success fee. However, in paying the dividend, no provision had been made for either.
208. At 471 - 472, Etherton J, having found that by virtue of Section 270(5) the dividend was unlawful, said this, suggesting that the liability of the directors was, subject to relief, strict or absolute:

"[135] Directors who cause their company to make ultra vires payments are in the same position as trustees who make payments in breach of trust, and are liable to make good the money so misapplied.

[136] As Kay LJ said in respect of an ultra vires investment by a company in Re Lands Allotment Co [1894] 1 Ch 616 at 638, [1891-94] All ER Rep 1032 at 1038:

"Then comes the question, what was the position of the directors who made an improper and ultra vires investment of that kind? Now, case after case has decided that directors of trading companies are not for all purposes trustees or in the position of trustees, or quasi trustees, or to be treated as trustees in every sense; but if they deal with the funds of a company, although those funds are not absolutely vested in them, but funds which are under their control, and deal with those funds in a manner which is beyond their powers, then as to that dealing they are treated as having committed a breach of trust. I do not believe that there has ever been deviation from the language of the late Sir George Jessel in the case of Re Forest of Dean Coal Mining Company [1878] 10 Ch D 450 at 453. Sir George Jessel said this: "Directors are called trustees. They are no doubt trustees of assets which have come into their hands, or which are under their control, but they are not trustees of a debt due to the company". So that, when they get assets of the company under their control, or into their hands, and deal with them in a way which is beyond the powers of the company, they are liable as for a breach of trust."

See also Re Exchange Banking Co, Flitcroft's Case [1882] 21 Ch D 519 esp at 535-536; Re Sharpe, Re Bennett, Masonic and General Life Assurance Company v. Sharpe [1892] 1 Ch 154 esp at 165; Selangor United Rubber Estates Limited v. Craddock (a Bankrupt) (No.3) [1968] 2 All ER 1073 esp at 1092, [1968] 1 WLR 1555 esp at 1575; Belmont Finance Corp v. Williams Furniture Limited (No.2) [1980] 1 All ER 393 esp at 404.

[137] It follows that, in authorising and procuring payment of the dividend, the Respondents were in breach of their duties as directors of MV and, subject to relief, are liable to account accordingly".

209. However, it was fundamental to Etherton J's finding that the dividend was unlawful that on any reasonable view, it was "likely" that the rollover relief claim would fail (see paragraph [133] at 471). Etherton J in fact held that if the directors had genuinely believed that the claim to rollover relief would be paid then they would have made provision for the success fee, and that had they believed that the rollover scheme would succeed then they acted unreasonably in failing to ensure that the relevant interim accounts made provision for the success fee.
210. In my judgment the extent to which, if at all, it is necessary to establish some element of "fault" on the part of the relevant directors before successfully recovering from them an unlawfully paid dividend is likely to turn on the basis upon which it is suggested that the dividend is unlawful as contravening the relevant statutory provisions.
211. In a case such as Re Loquitur, and a case such as the present where, on the basis of my findings above, the requirement to make provision of the kind referred to in paragraph 89 of Schedule 4 CA 1985 itself raises questions of reasonableness, once it is found that directors, for the purposes of interim accounts, ought reasonably to have caused the company to make provision for a particular liability, then it is likely to follow that if they did not then, subject to relief, they are likely to be found liable for breach of duty in respect of the payment of the unlawful dividend. On the other hand, if it was reasonable for them to not to cause the company to make provision for the purposes of paragraph 89 of Schedule 4, then no liability would lie because the dividend would not be unlawful. Where there is some other objection to the dividend than a failure to make provision for the purposes of paragraph 89, then different considerations may arise that I do not need to resolve as to the degree of fault (if any) that is required.
212. Thus, based on my findings in paragraphs 196 - 199 above, I consider that:-

212.1 the proper focus of inquiry in the present case is as to whether, at any particular time prior to the Composite Companies ceasing to trade, Mr Holland, or Mrs Holland (if I am wrong in my finding above that she was not a de facto director of the Composite Companies or my finding below that she was not in any event responsible for the payment of the dividends), ought not to have caused the dividends to be paid without first making provision for HRCT;

212.2 This turns on whether, on a reasonable and objective view of matters based upon what Mr and/or Mrs Holland knew or ought reasonably to have known as competent and diligent directors, it was more likely than not that HRCT was payable.

212.3 If not, then any interim accounts drawn up would not have been open to objection as not providing for HRCT, and dividends paid without making provision for the same would not have been unlawful.

(vi) Remedy

213. Mr Knox QC argues that if I were to find that Mr or Mrs Holland had acted in breach of their duties as de facto directors in causing the Composite Companies to pay dividends beyond a particular date, then the appropriate remedy is not to simply require them to account for the monies of the Composite Companies misapplied, subject to the Section 212 IA 1986 considerations discussed below, but to permit recovery only to the extent that there is some causal connection between the breach and the loss to the relevant Composite Company.
214. Mr Knox QC argues that had dividends stopped being paid earlier than they were, and before the new structure was in place, then additional liabilities in respect of claims by shareholders/employees and those to whom they were contracted would have arisen, that have been avoided in the events that have happened. He submits that this requires to be brought into account on any consideration of loss, and that on a proper analysis of the position the Composite Company suffered no loss.
215. Mr Knox QC submits that the position of Mr and Mrs Holland is, on the basis of the case as put by HMRC, analogous to that of the solicitors in Target Holdings Limited v. Redferns [1996] 1 AC 421, who paid away the finance company's/mortgagee's money with which it had been entrusted in breach of trust without having received any charge. The House of Lords there denied the finance company summary judgment for restitution of the monies paid away holding that it was necessary for the finance company to show that the breach had caused loss - see Lord Browne-Wilkinson at 432B - 434F, and 438A-439B. At 434B-C, Lord Browne-Wilkinson said this:-

"The basic right of a beneficiary is to have the trust duly administered in accordance with the provisions of the trust instrument, if any, and the general law. Thus, in relation to a traditional trust where the fund is held in trust for a number of beneficiaries having different, usually successive, equitable interests, (e.g. A for life with remainder to B), the right of each beneficiary is to have the whole fund vested in the trustees so as to be available to satisfy his equitable interest when, and if, it falls into possession. Accordingly, in the case of a breach of such a trust involving the wrongful paying away of trust assets, the liability of the trustee is to restore to the trust fund, often called "the trust estate," what ought to have been there.

The equitable rules of compensation for breach of trust have been largely developed in relation to such traditional trusts, where the only way in which all the beneficiaries' rights can be protected is to restore to the trust fund what ought to be there. In such a case the basic rule is that a trustee in breach of trust must restore or pay to the trust estate either the assets which have been lost to the estate by reason of the breach or compensation for such loss. Courts of Equity did not award damages but, acting in personam, ordered the defaulting trustee to restore the trust estate: see  Nocton v. Lord Ashburton  [1914] AC 932, 952, 958, per Viscount Haldane L.C. If specific restitution of the trust property is not possible, then the liability of the trustee is to pay sufficient compensation to the trust estate to put it back to what it would have been had the breach not been committed:  Caffrey v. Darby  (1801) 6 Ves. 488;  Clough v. Bond  (1838) 3 M. & C. 490. Even if the immediate cause of the loss is the dishonesty or failure of a third party, the trustee is liable to make good that loss to the trust estate if, but for the breach, such loss would not have occurred: see Underhill and Hayton, Law of Trusts & Trustees 14th ed. (1987), pp. 734-736;  In re Dawson, decd.; Union Fidelity Trustee Co. Ltd. v. Perpetual Trustee Co. Ltd.  [1966] 2 N.S.W.R. 211;  Bartlett v. Barclays Bank Trust Co. Ltd. (Nos. 1 and 2)  [1980] Ch. 515. Thus the common law rules of remoteness of damage and causation do not apply. However there does have to be some causal connection between the breach of trust and the loss to the trust estate for which compensation is recoverable, viz. the fact that the loss would not have occurred but for the breach: see also  In re Miller's Deed Trusts  (1978) 75 L.S.G. 454;  Nestle v. National Westminster Bank Plc.  [1993] 1 WLR 1260."

Further, at 439B, Lord Browne-Wilkinson said this:

Equitable compensation for breach of trust is designed to achieve exactly what the word compensation suggests: to make good a loss in fact suffered by the beneficiaries and which, using hindsight and common sense, can be seen to have been caused by the breach.

216. A similar argument to that now advanced by Mr Knox QC was advanced in the Court of Appeal in Bairstow. At 458 - 459, Robert Walker LJ said this:

[52] The facts of Target Holdings are well known and it is not necessary to set them out in detail. The case concerned a claim against a firm of solicitors sued for its involvement in a mortgage fraud. Fraud as well as negligence was pleaded. On completion of the transaction the solicitors had (in breach of their instructions) parted with the mortgage advance before obtaining the security. Within a month, however, they did obtain the security. The claimant, as a possible short cut to having to prove fraud at trial, sought summary judgment on the basis of the unauthorised payment, despite the solicitors having obtained the security (which subsequently proved hopelessly inadequate). That is the explanation of the references in the speech of Lord Browne-Wilkinson ([1995] 3 All ER 785 at 796 and 798, [1996] AC 421 at 437 and 439) to 'stopping the clock'.

[53] The result reached by the House of Lords in Target Holdings has been generally welcomed but the route to that result has been much debated (see in particular Sir Peter Millett, Equity's Place in the Law of Commerce (1998) 114 LQR at pp214 - 227; Professor C E F Rickett, Where are We Going with Equitable Compensation? in Trends in Contemporary Trust Law (1996) pp183 - 189). In my view it is unnecessary to go far into that debate, since whereas the trust in Target Holdings was (as Professor Rickett puts it) simply an aspect of a wider commercial transaction involving agency, the fiduciary obligations undertaken in this case by the former directors involved heavy and continuing responsibilities for the stewardship of the company's assets. They were not strictly speaking trustees, as title to the assets was not vested in them; but they had trustee-like responsibilities, because they had the power and the duty to manage the company's business in the interests of all its members. It may be that a more satisfactory dividing line is not that between the traditional trust and the commercial trust, but between a breach of fiduciary duty in the wrongful disbursement of funds of which the fiduciary has this sort of trustee-like stewardship and a breach of fiduciary duty of a different character (for instance a solicitor's failure to disclose a conflict of interest as in Canson Enterprises Ltd v. Boughton & Co (1991) 85 DLR (4^th) 129, a decision of the Supreme Court of Canada discussed by Lord Browne-Wilkinson [1995] 3 All ER 785 at 797, [1996] AC 421 at 438 - 439).

[54] These points were not fully explored in the course of argument and it would not be right to express any definite view on points which are not necessary to the determination of this appeal. It is sufficient, in my view, to observe that this is a wholly different case from Target Holdings, in which (so far as concerned the application for summary judgment) the solicitors were shown to have done no more than to have acted imprudently in disbursing their client's funds before they obtained their client's security. In this case the former directors are liable for deliberately and (at least in relation to the 1991 accounts) dishonestly paying unlawful dividends out of the company's funds which were in their stewardship. Those unlawful payments have never been reimbursed. Queens Moat's case does not depend on any artificial exercise in 'stopping the clock'. The judge (at p42 of the dividends judgment) rejected the submission that there was no loss because lawful dividends could and would have been paid, had the 1991 accounts reflected the true position. But even in the absence of such a finding, the submission was in my view bound to fail."

217. The present case is not one in which it is suggested that the directors have deliberately or dishonestly paid unlawful dividends. While Robert Walker LJ did not express a definitive view on the point, it is clear that Robert Walker LJ recognised a distinction between a bare trust arising in a a commercial transaction such as that in which the solicitors were involved in Target, and a situation such as the present where, if Mr or Mrs Holland are to be treated as de facto directors, one is concerned with heavy and continuing responsibilities for the stewardship of a company's assets, a distinction that has also been recognised by academic writers, see eg. Snell's Equity, 31^st Edition at paragraph 28-09:

"The approach to determining the amount of this liability depends on the kind of trust which has been breached. It has been said [Target Holdings v Redferns] that a distinction should be drawn between so-called "traditional" or active trusts and bare trusts in a commercial context.

An example of an active trust would be a settlement creating successive interests in a fund. The relevant feature is that the trustee owes a continuing duty to manage the fund and the beneficiaries' primary right is to compel the due administration of the trust. It is expected that the trust will continue after the trust has been remedied. Accordingly, the beneficiary's right is to require the trustee to reinstate the trust fund so that it will continue to be administered according to the terms of the trust….

A bare trust is one where the beneficiary is the absolute owner of the trust property and the trustee owes no continuing duties of management. In a commercial context, these are often created alongside a concurrent contractual relationship. The trustee's sole duty is to apply the trust property in accordance with the beneficiary's direction given in the terms of the contract. Since in many cases the beneficiary will have elected to rely on the underlying contractual transaction, he cannot require the trustee to reinstate the trust fund. His sole remedy, if any, is to sue directly for losses resulting to him from the misapplication of the trust money."

218. Although, in his opening address, Mr Knox QC did flag up that he would be taking the point that it was necessary for HMRC to prove loss, the point was not developed in his opening Skeletons, or indeed in his written Outline Closing Submissions, and Target was introduced as an authority during Mr Knox QC's oral closing submissions. Consequently the parties' submissions on the difficult and controversial issue as to the scope and effect of the decision in Target were somewhat limited. However, the cases demonstrate that the established remedy against directors liable in respect of the payment of an unlawful dividend or other ultra vires payment is to require the directors to reinstate the amount of the payment without an inquiry as to the amount of loss suffered by the company as a result of the relevant breach of duty. Given that we are here concerned with heavy and continuing responsibilities for the stewardship of a company's assets rather than a bare trust in a commercial context, I am not persuaded that the application of Target requires me to adopt a different approach on the present facts.
219. In the circumstances if any of the dividends paid were unlawful and if Mr or Mrs Holland are liable in respect thereof, then, subject to the operation of Section 727 CA 1985 or any discretion under Section 212 IA 1986, they would be liable for a sum equivalent to the unlawful dividends paid without HMRC having to prove that the breach of duty on their part had caused loss.

K Section 727 CA 1985

220. Section 727 CA 1985 provides that:

"If in any proceedings for negligence, default, breach of duty or breach of trust against an officer of a company … it appears to the Court hearing the case that the officer … is or may liable in respect of the negligence, default, breach of duty or breach of trust, but that he has acted honestly and reasonably, and that having regarded to all the circumstances of the case (including those connected with his appointment) he ought fairly to be excused for the negligence, default, breach of duty or breach of trust, that Court may relieve him, either wholly or partly, from his liability on such terms as it thinks fit."

221. It is not in dispute that Section 727 is capable of applying in the case of payment of an unlawful dividend. However, in addition to showing that he acted honestly, the onus is fairly and squarely on the officer to satisfy the Court that he acted reasonably in authorising and procuring payment of the dividend on the basis of the interim accounts - see Bairstow at 550 per Robert Walker LJ. This is a matter to be tested objectively. Further, if the officer gets over these hurdles, it is necessary for him to demonstrate that, having regard to "all the circumstances of the case", he ought fairly to be excused. The expression "all the circumstances of the case" primarily means the circumstance in which the breach took place – see Ultraframe v Fielding [2005] EWHC 1638 at [1451].
222. Section 727 relief was refused in Re Loquitur (supra), where, as we have seen, the directors had no genuine belief that the rollover scheme would work, and where an unprovided for success fee would be payable if it did, and Re Bairstow (supra), where there was a specific finding that the directors had falsified accounts.
223. Genuine reliance on professional advice might well render conduct which would otherwise be unreasonable as reasonable - see eg. Re Claridges Patent Asphalt Company Limited [1921] 1 Ch 543, cf. Loquitur (supra) 488 - 489.
224. The headnote to Loquitur suggests that the case decides that there is no jurisdiction to grant relief under Section 727 CA 1985 where, as a result of directors failing to exercise proper skill and care a dividend is paid that renders the company insolvent or potentially insolvent. However, I consider that this reads too much into Etherton J's judgment at 489 - 490. Whilst the Court will, necessarily, be most reluctant to grant relief under Section 727 when an officer/shareholder has benefited at the expense of creditors by reason of the payment of a dividend, I consider that the Court does retain a discretion to relieve at least when, as in the present case, the director has not directly benefited from the dividend itself.
225. In Re D'Jan of London Limited (supra) at 564, Hoffman LJ pointed out that the wording of Section 727 itself contemplates that conduct may be reasonable for the purposes of Section 727 despite amounting to lack of reasonable care at common law.
226. By extension it seems to me that it would be at least possible for conduct to be held to be "reasonable" for the purposes of Section 727 even though the conduct complained of was of a failure to make provision when, on a reasonable objective view, provision ought to have been made for HRCT.

L Section 212 IA 1986

227. In Loquitur (supra) at page 490, Etherton J said this:

"The IA, Section 212 discretion.

[245] If the Court finds, on an application under s212 of the IA, that a director has misapplied, or become accountable for any property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company, s212(3) confers on the Court a discretion to order the director to pay to the company the relevant property or any part of it or to contribute such sum as the Court thinks just. Counsel are all agreed that, in addition to the power of the Court to grant relief under s727 of the CA 1985, s212(3) of the IA confers a further discretion on the Court to determine precisely what or how much the director should be ordered to restore to the company so as to do what is just in all the circumstances.

[246] As Dillon LJ stated in West Mercia Safetywear Ltd (in liq) v. Dodds [1988] BCLC 250 at 253:

"The section [then s333 of the Companies Act 1948] … provides that the Court may order the delinquent director to repay or restore the money, with interest at such rate as the Court thinks fit, or to contribute such sum to the assets of the company by way of compensation in respect of the misapplication as the Court thinks fit. The Court has a discretion over the matter of relief, and it is permissible for the delinquent director to submit that the wind should be tempered because, for instance, full repayment would produce a windfall to third parties, or, alternatively, because it would involve money going round in a circle or passing through the hands of someone else whose position is equally tainted.

[247] In my judgment, it is appropriate in the present case, notwithstanding that the Court is unable to grant relief under s727 of the CA 1985, to limit the amount which should be paid by the respondents to MV to less than the full £5.9m paid by way of the dividend."

228. Etherton J, did then, in the exercise of his discretion under Section 212, provide for the award to be limited to the amount that ought to have been provided for.
229. Mr Knox QC submitted that Section 212 conferred a wide discretion to do what was fair in the circumstances. He submitted that, in the circumstances, it would be appropriate to exercise the discretion in such a way as to refuse HMRC relief on the basis that an award in their favour would be to confer upon them a "windfall", the point being that a charge to HRCT really ought not to have arisen, and could have been avoided by the Composite Companies had they not been set up in the way that they were but rather in such a way as avoided HRCT.
230. Unfortunately, the cases provide no real guidance as to the nature and extent of the discretion under Section 212 IA 1986. However, whilst I have some sympathy for the logic of Mr Knox QC's point, I am not persuaded that the discretion is as wide as he submits.
231. It is to be borne in mind that Section 212 is, essentially, a procedural section providing, to quote its heading, a "Summary remedy against delinquent directors", and for creditors to be able to bring a claim effectively on behalf of the insolvent company. It seems to me that the scope and purpose of the discretion under Section 212 is to reflect the fact that the remedy is capable of being pursued by a party other than the liquidator, and, in respect of a claim such as the present, to enable an award to be limited to what is required to make up any deficiency occasioned by the delinquency, the subject matter of the proceedings.
232. Given the express and carefully worded power of the Court to relieve under Section 727 CA 1985, it would, in my judgment, be odd if a procedural provision such as Section 212 had been intended to provide a further mechanism for relieving from liability based on broad and ill defined ideas of fairness.

M Result - Application of Principles to the Facts

(i) Mrs Holland

233. I have already found that Mrs Holland never became a de facto director of the Composite Companies. However, even if she did, I do not consider that she sufficiently participated in the decision to pay and continue to pay dividends to render her liable, and even if she was prima facie liable, I consider that it would be proper to grant her relief under Section 727 CA 1985.
234. The following are, in my judgment, the key considerations so far as Mrs Holland is concerned:

234.1 Whilst she processed the various transactions that led to the payment of the dividends, her role was, to all intents and purposes, simply a clerical one relating to a system that had been set up by Mr Holland with the benefit of professional advice from solicitors and accountants;

234.2 There is no evidence that she participated in the making of any decision relating to the payment of dividends, being content to leave the decision making to Mr Holland who she knew was receiving advice from Mr Newton and Mr Rees on an ongoing basis.

(ii) Mr Holland - Overview

235. In my judgment there is a clear distinction between the position between 24^th April 2002 (when HMRC submits that Mr Holland became liable in respect of payment of dividends) and 19^th August 2004 on the one hand, and the position from and after 19^th August 2004 on the other hand,
236. Applying the principles considered above, I consider that in the period up to 19^th August 2004 either Mr Holland was at no stage liable in respect of the payment of dividends, or if he was, that he ought to be relieved from liability pursuant to Section 727 CA 1985.
237. However, I consider the position after 19^th August 2004 to be different, and whilst I have not inconsiderable sympathy for Mr Holland, who I consider to be an honest man placed in difficult circumstances essentially through no fault of his own, I consider that the continued payment of dividends from shortly after 19^th August 2004 rendered him liable in circumstances in which it would not, in my judgment, be a proper exercise of the power under Section 727 to relieve him from liability.
238. My reasoning is as follows.

(iii) Period up to 19^th August 2004

239. I make the following general observations about this period:

239.1 There is no allegation of dishonesty or bad faith on Mr Holland's part, he plainly acted honestly throughout.

239.2 I also, and for reasons that I shall develop by reference to the facts, consider that Mr Holland acted reasonably throughout this period.

239.3 Throughout this period Mr Holland acted on professional advice from Neil Myerson (principally Mr Newton) and Mr Rees, as well as on the advice of Counsel, Mr Ginniff. Until the receipt of Mr McDonnell's Opinion on 9^th August 2004, the advice that Mr Holland was receiving was consistent to the effect that either HMRC would accept that it was wrong, or that the fact that HMRC was wrong ought to be capable of being established by way of appeal or judicial review.

239.4 The scheme, which was set up on legal advice from Mr Newton and Mr Ginniff, was set up in such a way that if provision had to be made for HRCT, and dividends had to be paid after so providing, then the scheme was not viable and the Composite Companies were likely to have had to cease trading at that point, at which stage the contractual liabilities referred to above are likely to have arisen.

239.5 The scheme was inherently flawed through no fault of Mr Holland, and as a result of the advice that he had received. It could have been set up in such a way as to be tax efficient, but was not. A number of other similar schemes had been set up which appear to have operated without the difficulties that the Composite Companies ultimately faced, and Mr Holland obtained comfort through the fact that the Composite Companies were by no means a one off.

239.6 I share Mr Tallon QC's view that HMRC had acted "badly" in relation to the way it handled the matter. As to this:

239.6.1 Even if Mr Watson's letter of 27^th April 2001 was not intended to be a response to Mr Rees' letter of 30^th March 2001, and I have already held that it is likely that it was intended to be such, HMRC, by Mr Watson, clearly gave the impression that the "association" point, and hence the ability to rely upon ESC C9, certainly in respect of Composite Companies 7, 8 and 10, had been conceded by HMRC.

239.6.2 HMRC could have taken the point in relation to S417(3) ICTA 1988 very much earlier based upon what it had been told by Speechley's letter dated 30^th March 2001. Had this been done, then the point is likely to have been more speedily addressed on behalf of the Composite Companies so that the present issues might never have arisen.

239.6.3 Further, either Mr Russell was, albeit perhaps not intentionally, grossly misleading when he spoke to Mr Rees on 27^th and 28^th May 2004, or HMRC changed its position again between these discussions and the meeting on 21^st June 2004.

239.7 Whilst I do not consider that this has quite the significance that Mr Knox QC seeks to attach to it, it is nevertheless the fact that had the original Corporate Structure been set up as it might have been, and as the new structure was set up in 2004, then the HRCT that the Composite Companies became liable for would never have become payable. To this extent HMRC has benefited from a "windfall". However, it should not be forgotten that tax that has become payable is tax payable, and a liability that has arisen is a liability however fortuitous the circumstances in which it might have arisen.

240. I turn now to consider the circumstances as they unfolded up to 19^th August 2004.
241. As to the setting up of the Composite Companies' corporate structure, HMRC placed great reliance on the reservations expressed in Mr Ginniff's Advice dated 22^nd January 1999, and the health warnings contained in Mr Newton's letter dated 2^nd February 1999 to the effect that until the first year's computation had been agreed, no guarantee could be given, and that there was the risk that the structure might be vigorously attacked.
242. However, Mr Ginniff's Advice and the letter dated 2^nd February 1999 require to be read in context. In particular:

242.1 Mr Ginniff's Advice was, at least to a trained legal eye, somewhat contradictory. However, it was reasonably confident, at least as regards the question of association between the Composite Companies.

242.2 The decision to go ahead appears to have been made on 26^th January 1999 after Mr Newton had explained to Mr Holland HMRC's response to Mr Ginniff's enquiry of HMRC, and his conversation with Mr Simmonds, and Mr Holland was subsequently provided with Mr Ginniff's file note of his conversation with Mr Simmonds. As the file note reflects, this was entirely positive, albeit that Mr Holland was advised by the letter dated 2^nd February 1999 that HMRC could not be bound by Mr Simmonds' indication.

242.3 Although Mr Newton's letter dated 2^nd February 1999 identified risks, Mr Newton, a matter of days later on 8^th February 1999, provided the precedent documents for setting up and running the Composite Companies, including the standard form of resolution for declaring dividends. Mr Newton did not then, or at any stage, advise that provision should be made for HRCT until such time as certainty had been achieved as to the association point and the applicability of ESC C9. To the contrary, as I see it, the provision of the precedent documentation impliedly gave a green light to Mr Holland to put the relevant Corporate Structure into operation, and to pay and to carry on paying dividends without providing for HRCT.

242.4 Mr Holland was aware, and had the comfort, that the Composite Companies' structure was one of many operating throughout the country, and seemingly achieving the benefits that were sought to be achieved by the operation of the Composite Companies.

243. In the above circumstances, I am firmly of the view that if detailed consideration had been given to the point in, say, March 1999, then, applying the criteria identified in paragraph 212 above, and in carrying out the evaluative exercise required for the purposes of producing interim accounts that enable a "reasonable judgment to be made" within the meaning of Section 270(3) CA 1985, it would not then have been incumbent upon Mr Holland to cause the Composite Companies to make provision, for the purposes of paragraph 89 of Schedule 4 CA 1985, for the potential liability for HRCT even though, with hindsight, it is now known that the liability had arisen.
244. Alternatively, if Mr Green is right and Mr Holland is otherwise liable in respect of the payment of unlawful dividends, then I consider that a clear case was, in the above circumstances and taking into account the above considerations, made out for relief under Section 727 CA 1985 in respect of that liability on the basis that he had acted honestly and reasonably, and that having regard to all the circumstances of the case he ought fairly to have been excused. As indicated, HMRC concede as much up to 24^th April 2002.
245. The question thus arises as to whether, as time went on and the circumstances developed, the stage was reached at which, for the purposes of producing interim accounts, provision ought to have been made for HRCT in circumstances in which Mr Holland is liable because it was not made, or, alternatively, that relief under Section 727 CA 1985 should no longer be available.
246. An initial point that arises is that between November 1988 and July 1999 Mr Holland caused Paycheck Services 2 to continue to pay dividends, knowing that profits exceeded £300,000 per annum, without making provision for HRCT. This resulted in an outstanding liability of £75,000, which is comparatively modest compared with the sums claimed in this action. The failure to make provision for this HRCT is, plainly, unfortunate. However, it occurred many years ago, Mr Holland personally contributed substantial funds of approximately £35,000 towards making up the deficit, and no action has been taken by the liquidator of Paycheck Services 2 or by HMRC as a creditor specifically in relation to Paycheck Services 2. In the circumstances, I am not persuaded that such defaults as there may have been in relation to Paycheck Services 2 are so significant that relief under Section 727 CA 1985 should be refused in consequence thereof in respect of the period up to 19^th August 2004.
247. There is evidence that, in the early years, and despite the advice given by Mr Newton in his letter dated 2^nd February 1999, the profits of certain of the Composite Companies exceeded £150,000. However, there is no clear evidence that this, in itself, gave rise to an obligation to pay HRCT, and there is no clear evidence that the profits of any one Composite Company, when aggregated with the profits of Paycheck Services, exceeded £300,000. Further, the file note of Mr Ginniff's conversation with Mr Simmonds would have indicated to Mr Holland that Mr Simmonds did not perceive "association" between the Composite Companies and Paycheck Services. Consequently, I am not satisfied that this factor required or requires any different approach.
248. Going back to the sequence of events, nothing much of significance occurred until the correspondence in early 2001. However, the conclusion to this was Mr Watson's letter dated 27^th April 2001, and I have already found that Mr Holland and his advisors were entitled to place reliance on this letter as being a reasoned response to Mr Rees' letter dated 30^th March 2001. Consequently Mr Holland was, in my judgment, entitled to place considerable reliance and comfort upon this letter.
249. As I have described, in November 2001 Mr Rees raised the issue of the loans made by certain of the Composite Companies to Paycheck Services 2, and as to the possible effect of this upon the ability to rely upon ESC C9 given the requirement therein of "no past or present connection". However, as we have also seen Mr Cockerill of Neil Myerson, on or about 5^th November 2001, gave fairly robust advice to the effect that the loans would not "cause association". In these circumstances, and given the green light that had already been given by Mr Watson's letter dated 27^th April 2001, I do not consider this factor to be of material significance.
250. One then has the correspondence from Mr Williams of HMRC between 11^th February 2002 and 11^th March 2003. It is certainly true that Mr Williams was, in this correspondence, expressing a view different from that that had been expressed by Mr Watson in his letter of 27^th April 2001 and HMRC was, by Mr Williams, suggesting that there was "association". However, the following points can fairly be made about this correspondence:

250.1 Mr Rees' advice to Mr Holland was that a new Tax Inspector had taken over the case, and that he would, once he understood the issues, accept, as had Mr Watson, that there was no association. The evidence was that this, not unreasonably in the circumstances, reassured Mr Holland. It was also consistent with Mr Williams stating that he was still researching the issues.

250.2 Although the correspondence went on for some time, and Mr Williams appeared not to be persuaded, Mr Rees remained confident that HMRC would ultimately be persuaded, and that the position taken by the Composite Companies was right.

250.3 Further, whilst Mr Rees had, by his letter dated 30^th March 2001, provided detailed reasoning as to why it was said that ESC C9 applied, and why there was no association based thereupon, no detailed rebuttal was provided by Mr Williams, and Mr Williams repeatedly stated that he was continuing to research the matter. The only clear reason advanced by Mr Williams was that ESC C9 was designed to assist banks and trust companies, but Mr Rees was able to point to the fact that the wording of ESC C9 was not so limited.

251. In late 2002/early 2003, Mr Rees raised, again, the issue in relation to monies "borrowed" by Paycheck Services from certain of the Composite Companies, and the outstanding loans to Paycheck Services 2. However, one can well see that the meeting on 21^st January 2003 resolved matters to Mr Holland's and Mr Rees' satisfaction. The advice received by Mr Holland was to the effect that the monies "borrowed" from certain of the Composite Companies by Paycheck Services were properly treated as sums properly invoiced by Paycheck Services to the Composite Companies for fees, and that whilst this created a deficit, which was ultimately cleared, it did not support a case of "association". So far as the loans to Paycheck Services 2 are concerned, Mr Cockrill had already advised that these did not lead to "association". Further, it was not suggested to Mr Holland at the meeting on 21^st January 2003 by either of his professional advisors, Mr Newton or Mr Rees, that the Composite Companies should now start making provision for HRCT before paying dividends, or stop paying dividends, or cease trading. It is certainly true that Mr Holland did not specifically seek advice as to whether it was appropriate to continue paying dividends, or to do so without making provision for HRCT. However, in my judgment, there was no reasonable cause for him to do so, and the circumstances were such that Mr Holland might reasonably have expected such advice to be given if the circumstances were such that action required to be taken.
252. Mr Green, on behalf of HMRC, complains that the issues in relation to these loans ought to have been disclosed to HMRC, and that the fact that there was no disclosure in relation to these matters is a factor that I should take into account in refusing to grant relief pursuant to Section 727 CA 1985. However, I consider that if any such disclosure was required, then it was up to Mr Rees to advise that such disclosure was required and Mr Holland was not personally to know that such disclosure might be required. In these circumstances, I am satisfied that any failure to disclose is not a matter that materially bears upon the question of relief under Section 727.
253. Nothing essentially happened between Mr Williams' letter of 11^th March 2003, and the correspondence of 4^th and 8^th December 2003 whereby Mr McGillivray opened enquiries and raised assessments for the year ended 31^st July 2001 and issued closure notices for 2000 and 2002. These were, of course, serious steps. However, no further reasoning was provided by HMRC, and Mr Rees remained confident as to the position. Further, Mr Rees initiated what was believed to be the correct appeals procedure.
254. Events were somewhat overtaken in early 2004 by what appeared to be the very real possibility that the advantageous PAYE treatment that underpinned the logic behind the Composite Companies and the payment of dividends would be removed in the forthcoming budget. This necessarily called into question the whole viability of the Composite Companies, and the discussions at the meeting on 24^th February 2004, and Mr Newton's note of that meeting, have, I consider, to be viewed in this context. However, there was, at the meeting on 24^th February 2004, specific consideration of the merits of the Composite Companies' position in relation to the question of association and the applicability of ESC C9 and, as I have already found, Mr Rees at least remained confident as to the position.
255. Whilst there was discussion at the meeting on 24^th February 2004 as to the extent of the outstanding liability if HRCT were payable, and a consideration of the possibility of wrongful trading, at no point did either Mr Newton or Mr Rees suggest to Mr Holland that the Composite Companies should stop paying dividends, or at least not pay dividends without making provision for HRCT. Again, whilst it is right that Mr Holland did not specifically ask for advice on the point, in the context of the meeting this is, in my judgment, the sort of advice that Mr Holland might reasonably have been expected to receive from his professional advisors if this was something that he ought to have done.
256. I have set out in some detail above the events of 27^th and 28^th May 2004, and the two telephone conversations and one meeting between Mr McGillivray and Mr Rees. However, I am satisfied that the message that came out from those discussions, and that would have been communicated to Mr Holland was that HMRC were, in the light of Mr Watson's letter dated 27^th April 2001, prepared to concede that no question of association arose in relation to Composite Companies 3 – 45, and thus that there was no outstanding liability for HRCT.
257. The position plainly moved on with the events at the meeting on 21^st June 2004, and the subsequent receipt of Mr Russell's letter dated 25^th June 2004 making express reference to Section 417(3) ICTA 1988. However, even then:

257.1 The matters discussed on 27^th and 28^th May 2004 pointed, at the very least, to real internal uncertainties within HMRC as to the effect of the concession made by Mr Watson by his letter dated 24^th April 2001.

257.2 Following the meeting, and the receipt of the letter dated 25^th June 2004, Mr Ginniff was instructed, and gave reasonably confident advice as to the ability to bring judicial review proceedings notwithstanding the lapse of time, and as to the overall merits.

257.3 At the meeting on 21^st June 2004, Mr Russell had held out the real possibility of a deal with HMRC, certainly in respect of current accounting periods.

257.4 Further, at this stage, none of Mr Holland's professional advisors was advising him that he ought to cause the Composite Companies to stop paying dividends, or at least to stop paying dividends without making provision for HRCT.

258. Circumstances plainly changed dramatically with the receipt of Mr McDonnell's opinion on 9^th August 2004. Mr McDonnell's advice could not have been clearer to the effect that the Composite Companies were liable to pay HRCT on the basis that ESC C9 did not apply. Further, Mr McDonnell had specifically dealt with Section 417(3) ICTA 1988 whereas, for some reason, Mr Ginniff had not.
259. I consider the evidence reasonably clear to the effect that upon receipt of Mr McDonnell's Advice the decision was taken that if the business was to continue in any form, then it would be necessary to set up a new compliant corporate structure and the decision was taken to proceed along those lines. However, whatever deficiencies there may have been with Mr Ginniff's advice, Mr McDonnell's Opinion plainly came as a shock to Mr Holland, and his advisors, Mr Newton and Mr Rees. In those circumstances, I consider it was perfectly reasonable, provided such step was taken expeditiously, to seek a definitive opinion from leading Counsel, namely Mr Tallon QC, before taking the drastic, and to all intents and purposes terminal, step of stopping paying dividends before a new compliant structure was in place, so as to lead, almost inevitably to the Composite Companies ceasing to trade, and liabilities arising thereon that would not otherwise have arisen.
260. In the above circumstances, I am satisfied that, up to the time of seeing Mr Tallon in Consultation on 18^th August 2004:

260.1 Applying the criteria identified in paragraph 212 above, and in carrying out the evaluative exercise required for the purposes of producing interim accounts that enabled a "reasonable judgment to be made", it was not necessary until then to make provision for the potential liability for HRCT. Consequently payment of the dividends was not unlawful;

260.2 Mr Holland was not otherwise in breach of his duties as a de facto director of the Composite Companies in continuing to cause them to pay dividends, having reasonable grounds for doing so;

260.3 If, in relation to the period prior to 18^th August 2004:

260.3.1 Applying the criteria referred to in paragraph 212 above, provision ought to have been made for HRCT, and Mr Holland is otherwise liable by reason thereof; or

260.3.2 Mr Green is right that stricter criteria ought to be applied as to the circumstances in which provision ought to have been made for HRCT, and Mr Holland is otherwise liable in respect thereof ;

then it is my firm view that this is a proper case for the Court to grant relief pursuant to Section 727 CA 1985 on the basis that Mr Holland acted honestly and reasonably, and that having regard to all the circumstances of the case he ought fairly to be excused from any liability. The present case is very different from Bairstow, where the directors had deliberately falsified accounts, and Re Loquitur, where the directors had no genuine belief that the rollover scheme worked. I am conscious of the total amount of the dividends in question, and that this would involve relieving from the consequence of the payment of unlawful dividends, but on the particular facts of the present case, I consider that it would be correct to do so.

(iv) Period after 18^th August 2004

261. As Mr Knox QC realistically recognised, the position following the Consultation of Mr Tallon QC on 18^th August 2004 is very much more difficult.
262. As to the position following the Consultation:

262.1 Whilst Mr Tallon QC thought that Mr McDonnell had, perhaps, been rather "harsh" in respect of the tax avoidance point, Mr Tallon QC essentially confirmed Mr McDonnell's advice, and whilst advising that permission to seek judicial review might be granted, he advised that an application for judicial review was likely to fail. Consequently, once Mr Tallon QC had confirmed Mr McDonnell's view as to the liability for HRCT, Mr Holland can have had no reasonably held belief that HMRC's claims to HRCT would, ultimately, be defeated.

262.2 Further, whilst Mr Tallon QC settled a letter to HMRC with a view to establishing a negotiating position, it does seem to me that, on the evidence, the prospect of doing a deal with HMRC, and certainly one involving both the setting up of a new compliant corporate structure and HMRC foregoing its claim to continuing HRCT, was by this stage, as I see it, no more than speculative.

263. Although in his evidence in chief relating to the discussion on the train on 18^th August 2004, Mr Newton described being optimistic as to the prospects of doing a deal, I consider that Mr Newton's and Mr Rees' contemporaneous views as expressed in the file note of the telephone conversation on 10^th August 2004, and Mr Rees' letter dated 25^th August 2004 are a sounder guide to contemporary perceptions, and the true reality of the position. On 10^th August it had, according to his file note, been Mr Newton's view that if the there was to be a re-structuring rather than a total cessation of trading, then it seemed that HMRC would not alter the assessments. This was consistent with the way that matters had been put in the Instructions to Mr Ginniff which were also used as the basis of the Instructions to Mr McDonnell, where it was suggested that HMRC had indicated that if the Composite Companies were closed down, then HMRC would not pursue past and current accounting periods, the then current accounting period being due to expire on 31^st July 2004. It was suggested in submissions that Mr Tallon QC had presented a somewhat more optimistic view as to the prospects of a deal. Whilst Mr Tallon QC had certainly endorsed a strategy for attempting to achieve a deal by responding robustly to Mr McGillivray's letter of 25^th June 2004, the file note of the Consultation does not refer to Mr Tallon QC holding out great hopes of achieving a deal. Further, notwithstanding the advice given by Mr Tallon QC, Mr Newton felt it necessary to make express reference at the Consultation to the risk that Mr Holland was wrongfully trading. In addition to this, if there really had been a sense of optimism after the Consultation, this was not reflected in either Mr Holland's attitude on the train returning from London, or Mr Rees' letter of 25^th August 2004.
264. In these circumstances, I have little doubt that, applying the criteria referred to in paragraph 212 above, any interim accounts ought, from then on, to have made provision for HRCT and, consequently, that any dividend paid thereafter was unlawful. Further, subject to the question of relief under Section 727 CA 1985, I consider that, by virtue of the considerations referred to in paragraph 212 above, Mr Holland is liable in respect thereof.
265. Mr Knox QC submitted that the continued trading, and the payment of dividends was reasonable and justified from and after 18^th August 2004 on the basis that:

265.1 There were reasonable prospects of doing a deal with HMRC; and

265.2 Mr Holland was between a rock and a hard place, and faced a balancing exercise between ceasing to cause the Composite Companies to pay dividends with the result that they ceased to trade, giving rise to contractual liabilities that would otherwise not have arisen, on the one hand, and continuing to cause the Composite Companies to pay dividends and trade, albeit continuing to incur an unprovided for liability for HRCT. Mr Knox QC's point was that whilst the Composite Companies might, as they in fact did, end up being in no position to pay the HRCT that continued to accrue, if trading continued until the business could be transferred to a new corporate structure, then the contractual liabilities, some of which were likely to be preferential, would be avoided, with the result that, overall, HMRC would benefit and gain given, further, that if trading had ceased, then no further HRCT would have become payable in any event. Mr Knox QC referred me, in closing, to Re Welfab Engineers Limited [1990] BCLC 833 as authority for the proposition that the Court ought to take a sympathetic view where some step is taken by the directors in the face of insolvency which is, in itself, disadvantageous, but which might have resulted in benefit for creditors as a whole.

266. As to the prospects of doing a deal with HMRC, based upon the matters referred to in paragraph 263 above, I am, as I have said, unable to conclude that there was much better than a speculative chance of doing a deal with HMRC that would have allowed for the setting up of a new corporate structure, as well as relieving the Composite Companies from liability for ongoing HRCT. Consequently, I do not consider that the prospect of doing a deal with HMRC, certainly by itself, justified continuing to pay unlawful dividends. There is the further point that whilst the letter dated 19^th August 2004 did suggest a further meeting, there is no evidence of any attempt to chase HMRC to arrange that meeting until Mr Newton telephoned HMRC on 15^th September 2005 some four weeks later.
267. There is force in the point that a director might be taken to have acted reasonably where, with the benefit of all appropriate professional advice, he causes a company to continue to trade notwithstanding that it is insolvent where it is perceived that doing so will be to the benefit of creditors as a whole. In these circumstances, and provided that the director has conducted the relevant balancing exercise after having fully informed himself as to the alternative courses of action available, and their possible consequences, the Court might well be reluctant to gainsay the exercise by the director of his commercial judgment even if it turns out that he has made the wrong decision.
268. However, given the acute circumstances that confronted Mr Holland following the Consultation on 18^th August 2004, I consider that he faces the following difficulties in raising a Section 727 CA 1985 defence in respect of the payment of dividends thereafter:

268.1 There is no real evidence that Mr Holland did conduct a properly informed balancing exercise at the appropriate time. The relevant points are pleaded in general terms in the Defence, and referred to in general terms in Mr Holland's second witness statement. Whilst I have found that Mr Newton advised on the point on the train on 18^th August 2004, I have also found that Mr Holland was then in no mood to take in that advice, and that there is, apart from the generalised suggestions in the Defence and Mr Holland's second witness statement evidence, no evidence that the advice was subsequently given (or sought), let alone acted upon.

268.2 Whilst Mr Rees might, on the train, have given "back of an envelope" advice as to the likely contractual liabilities if the Composite Companies were to cease trading at that stage, the quality of the information, as I see it, fell well short of the sort of information that a reasonably competent director ought to have obtained for the purposes of the sort of balancing exercise that Mr Knox QC referred to. In re-examination, Mr Newton gave some evidence as to the level of creditor claims that would have arisen had the Composite Companies gone into administration or liquidation before a seamless transfer of their respective businesses and employees to new composite companies could be achieved. He referred to figures of between £400,000 and £450,000, although figures of rather less than that were referred to at the meeting with Mr Russsell and Mr McGillivray on 4^th October 2004 . However, there are a number of difficulties with this:-

268.2.1 There is no evidence that Mr Holland, in the aftermath of the Consultation on 18^th August 2004, had before him anything approaching accurate figures as to the likely contractual liabilities which he looked at in order to exercise a judgment to carry on paying dividends and trading. Further, as I have already indicated, there is no evidence that Mr Holland carried out any properly informed analysis based on figures and likely outcomes in order to form a proper view as to whether dividends should continue to be paid.

268.2.2 Whilst Mr Rees came up with "back of an envelope" figures on the train, it is by no means clear that they were discussed with Mr Holland before he took himself off to sit elsewhere, and even if they were, it is clear that he did not take them in. Further, there is no evidence that he subsequently used them, or that advice was subsequently given to him in respect thereof.

268.2.3 Whilst there may be issues as to whether, if trading had ceased earlier, there would have been preferential employee claims that ranked ahead of HMRC, the plain fact is that continuing to pay dividends did increase the total sum ultimately owed to HMRC on administration and liquidation, fortuitous in a sense though that might have been.

268.2.4 Without comparative outcome statements comparing the likely position if dividends had stopped being paid shortly after 18^th August 2004, with the actual position, it is difficult to safely conclude that creditors as a whole, let alone any particular individual creditor or creditors, are necessarily better off because trading continued until administration. It is thus difficult to say, with any degree of certainty, except that additional unpaid HRCT arose, what the effect of continued trading was, and in particular whether, and if so to what extent, HMRC benefited from the fact that other contractual, and in particular preferential, claims did not arise because of the seamless transition to the new corporate structure on administration.

268.3 If judicial review proceedings were likely to fail, and Mr Holland cannot by then have reasonably believed otherwise, then, subject to any deal with HMRC, the Composite Companies were indebted to HMRC in respect of sums substantially in excess of £3m which they were in no position to pay. In my judgment the circumstances cried out for specialist insolvency advice. Mr McDonnell had flagged up the need for specialist advice having advised that the Composite Companies should either cease trading or move to a compliant structure "as soon as practicable lest there be a substantial unbudgeted tax liability for the current accounting period". Mr Tallon QC had clearly indicated that he could not give that advice. Whilst Mr Newton gave evidence to the effect that Steven Conn, as an insolvency practitioner, had subsequently indicated that he thought that the directors had acted reasonably and properly, on any view, it is clear that any discussion with Mr Conn took place some time after 18^th August 2004, and Mr Conn not having been called to give evidence, it is by no means clear what, exactly, Mr Conn was informed about the circumstances. In giving evidence on behalf of HMRC, Mr Powell gave evidence of a much later discussion with the other joint administrator, Mr Stanley, to the effect that when fully informed about the circumstances, Mr Stanley took a less benevolent view. However, the point is that specialist insolvency advice was not taken at the relevant time and as part of a process of considering, immediately after Mr Tallon QC had advised as he had, whether dividends ought to be continued to be paid and trading continue. I consider that any director acting reasonably would have recognised the urgent need for this advice following the events of 18^th August 2004.

268.4 On the present facts, an insolvency practitioner might well have advised that the balancing exercise was one more appropriately carried out by or in Consultation with the Composite Companies' creditors (including HMRC) rather than by Mr Holland on his own, particularly bearing in mind that, on any view, it was difficult to see that there was substantially more than a speculative chance that administration or insolvent liquidation could be avoided. An insolvency practitioner is also likely to have advised that any meeting with HMRC take place as a matter of urgency.

268.5 Finally, but not least, the Court ought to be slow in condoning the payment of unlawful dividends, and there is force in Mr Green's point that there is a distinction between trading whilst insolvent, which may or may not amount to wrongful trading dependent upon the facts, and unlawfully paying dividends.

269. I have already indicated that I have not inconsiderable sympathy for Mr Holland. He found himself in very difficult circumstances, ultimately through little if any fault of his own, and as a result of what may well have been poor advice in relation to the setting up of the Composite Companies for which he may have a remedy elsewhere. However, whilst Mr Holland plainly acted honestly at all times, I am not satisfied that, in the circumstances, he acted reasonably at all times after 18^th August 2004, or that, having regard to all the circumstances of the case, he ought fairly to be excused from liability. In my judgment, from after the Consultation with Mr Tallon QC on 18^th August 2004, Mr Holland, in continuing to cause the Composite Companies to pay dividends, and doing so without taking all appropriate advice and without properly informing himself as to the merits, so far as creditors were concerned, of the alternative courses of action that might have been open to the Composite Companies, took an unacceptable risk at (at least the potential) expense of HMRC with a view to seamlessly getting the new corporate structure in place.
270. Whilst I consider that Mr Holland is entitled to a few days grace until, in my judgment, 23^rd August 2004 in order to enable him to take stock following the Consultation with Mr Tallon QC, I find that Mr Holland is liable in respect of the payment of dividends from and after 23rd August 2004 in circumstances in which it would not be appropriate to relieve him pursuant to Section 727 CA 1985.

(v) Result

271. It follows from my findings above, that Mr Holland is, prima facie, liable to repay the dividends paid from and after 23^rd August 2004. The core complaint, as established, is, as I see it, the failure to provide for Corporation Tax by making provision for HRCT in respect of continued trading after that date. In these circumstances, in the exercise of my discretion under Section 212 IA 1986, I consider it appropriate to limit the award against Mr Holland to the amount of HRCT that the Composite Companies failed to provide for that fell or accrued due in respect of trading between 23^rd August 2004 and the date of administration (19^th October 2004), ie. the difference between the outstanding HRCT liability as at 19^th October 2004 and that as at 23^rd August 2004, reflecting the HRCT arising between those two dates.
272. Mr Green, in an e-mail sent to me after my draft Judgment had been circulated, in order to seek clarification of this part of my Judgement, posed the question as to whether, in finding as above, I would be …."accepting that Mr Holland was allowed to continue paying dividends so long as he just deducted new HRCT from those dividends and he did not have to provide for the £3m of unpaid HRCT".
273. It was, of course, the Composite Companies that paid the dividends, and not Mr Holland, and the present issue is whether and to what extent Mr Holland is, in misfeasance proceedings brought by HMRC as a creditor, liable as a de facto director for having caused the Composite Companies to pay unlawful dividends between 23^rd August 2004 and 19^th October 2004. The answer to the substance of Mr Green's question is, however, no. All the dividends paid between those dates were, on the basis of my findings unlawful, and to that extent should not have been paid. However, I ask myself what the result would have been if the Composite Companies had, following the meeting with Mr Tallon QC, continued to pay dividends but, contrary to the practice prior thereto, made full provision for ongoing HRCT by reducing the dividend payments accordingly. The dividends would, of course, still have been unlawful because the outstanding substantial liability for HRCT as at 23^rd August 2004 would, for the purposes of Section 270 CA 1985, and interim accounts prepared for the purposes of Section 273 CA 1985, have had to have been provided for so as to comply therewith. However, having found as I have in relation to the period prior to 23^rd August 2004, and given the particular circumstances of the present case and the connection between the payment of dividends and the work actually done by the contractors/shareholders, and charged for by the Composite Companies on an ongoing basis as described above, generating what would otherwise have been distributable profits, I would almost certainly, in the circumstances, have been prepared to relieve Mr Holland from liability under Section 727 CA 1985.
274. On the basis of my findings, the culpable failure in the present case is, as I have said, the continued payment of dividends after 23^rd August 2004 without providing for the further HRCT that became due as a result of the continued trading, with the consequence that HMRC lost out to the extent thereof. To limit the award against Mr Holland in the way that I propose to do in accordance with my discretion under Section 212 IA 1986 is consistent my finding as to the scope of the discretion under Section 212 referred to in paragraph 231 above, and, I believe, the approach taken by Etherton J in Re Loquitur (supra), and so limiting the award reflects the circumstances in which the present claims have been brought, namely by HMRC in a liquidation in which they are the only substantial creditor. However, for the reasons explained in paragraphs 231 and 232 above, contrary to Mr Knox QC's submissions, I do not consider that there is any wider discretion under Section 212 IA 1986 to relieve Mr Holland from liability.
275. I would add that even if Target Holdings v Redferns ought to be applied in the present case in the way suggested by Mr Knox QC, I am far from convinced doing so would have led to any different result.
276. I am not asked to assess the amount of the relevant award. I will, if necessary and if agreement cannot be reached, hear further submissions as to the appropriate form of relief.
277. For the reasons given above, the claims against Mrs Holland are dismissed.