From the start, it has been made clear that incorrect use of the Coronavirus Job Retention Scheme will lead to clawback by HMRC. But, in many cases, it has been hard for companies to know for sure if they are using the Scheme correctly – the rules are vague. Understandably, in many cases, companies have just decided to "go for it" and use the Scheme given the looming crisis.
The government has now announced (29 May 2020) a consultation on a retrospective statutory regime for clawback of grants. How this regime will work will have a big impact on managing risk for businesses and stakeholders such as auditors, investors, purchasers and insurers. And, the signs are that the regime will be harsher than was expected by us and others, with the burden being on users of the Scheme to show they were entitled.
This briefing looks at the proposed enforcement regime. It considers where businesses, which are dealing with uncertainty around entitlement to grant, may face reclaims by HMRC, and where directors may be personally liable. We also look at what boards of directors should do now to minimise that risk and deal with concerns that auditors, lenders, shareholders and potential investors may in the meantime raise. We are already seeing clawback risk come up as an audit and an M&A warranty and indemnity issue.
The clawback proposals
The proposals confirm that furlough grants will be taxable such that, where a recipient is not entitled to a grant under the Scheme or has misused it, then the grant is subject to income tax at 100% – effectively clawing back the whole grant.
As expected, the clawback may apply to genuine errors by businesses in using the Scheme, and not just deliberate or reckless misuse. It will apply where, amongst other things, the claimant has ceased to be entitled either because of a change in circumstances or because it has not, within a reasonable period, used the grant to pay the costs it was intended to cover.
Treating the grant as taxable in this way means that:
- HMRC will be able to enforce repayment by using their information powers, imposition of penalties and enforcement through assessments and ultimately appeals to the Tax Tribunal.
- HMRC will be able to investigate four years after the grant was made, with extended time limits of six years for careless behaviour and 20 years for deliberate misuse.
- Businesses will be required to notify HMRC if they know that they have received payment of grant to which they were not entitled. Penalties will be applied for failure to notify.
- The regime is retrospective, applying to all grants made under the Scheme.
- As the repayment is classified as a tax liability, other regulatory tax regimes apply. Accordingly, compliance will need to be included in risk reviews and Senior Accounting Officer compliance processes.
- Once an assessment is raised the burden of proof will be on the taxpayer to show HMRC is wrong. In the unclear world of the Scheme, the rules of which are vague in certain key resects, establishing entitlement may be difficult.
Personal liability of directors
If a company is insolvent when a reclaim is made then directors (or shadow directors) may be personally liable where:
- the director is responsible for the management of the company; and
- the director knew at the time that the liability to pay HMRC crystallised that the company was not entitled to the grant.
This will be a serious issue for the management of companies close to financial viability where the Scheme has been a real lifeline. Directors will need to be able to show that they did not know the company did not qualify for the grant.
For deliberately fraudulent claims, HMRC may prosecute. The Guidance expressly highlights fraudulent claims, with an online portal launched to enable the public to report suspected fraud. Given the relatively limited checks in the claims process itself, this is not surprising; and the Scheme is open to deliberate abuse. Examples of this could be an employer requiring employees to come back to work during furlough knowing that this breaches the Scheme conditions, or an employer claiming for workers without intending to use grant to pay those workers or not otherwise passing on 100% of the grant received to workers.
For the most egregious cases, HMRC are likely to prosecute, if only to show they have taken action. Current offences include fraud by misrepresentation in the Fraud Act 2006 and the common law offence of cheating the public revenue could apply.
When might companies be deemed to have made mistakes, triggering clawback risk?
There is still much uncertainty about entitlement under the Scheme. The rules of the Scheme are set out in HMRC guidance (which has changed several times in the last few months) and a Treasury Direction (amended on 20 May 2020) under the Coronavirus Act 2020.
The Guidance seeks to set out the circumstances in which a claim can be made, but leaves open some important questions regarding validity of claims. For example, the Guidance says that the claim can be made where "you cannot maintain your current workforce because your operations have been severely affected" by Covid-19. The Direction states that "No CJRS claim may be made in respect of an employee if it is abusive or is otherwise contrary to the exceptional purpose of CJRS". It is still unclear what these statements mean, and the consultation does not offer any help. The consultation covers how a reclaim will be made rather than what will trigger the reclaim.
As a result of this lack of clarity in the Guidance and Direction, many businesses have had to make decisions about eligibility to furlough grant on the basis of what they assume the government intended. But there are major areas of uncertainty including:
- Will businesses have to show, if challenged, that their operations have been severely affected by Covid-19? How do they show this? (Note that the similar schemes operated in other countries require satisfaction of objective criteria, which has been criticised as excessively bureaucratic, but has offered businesses some certainty).
- Does Covid-19 have to be the primary factor in the need to furlough workers and what if it was for a mixture of reasons? What if there is evidence that in fact you did not really want or need the relevant workers anyway?
- What if you have, meanwhile, distributed profits as dividend or paid bonuses for senior staff? Could those have been used to pay workers?
- The Scheme permits the re-engaging of previously terminated workers so that they can be entitled to benefits under the Scheme. Likewise, furlough leave can be backdated for workers. However, the rules and requirements around these issues are vague and full of potential pitfalls. There is room for legitimate differences of interpretation in relation to how payments are calculated and what workers are entitled to while on furlough, especially where the worker receives variable pay.
- It is still unclear whether payments of so-called discretionary bonuses can be classed as regular payments that can be included in reference salary calculations – and what the knock on risks of doing that are.
- What about claims under one version of the Guidance which are subsequently not deemed "correct" as the Guidance has been updated? For example, what if workers had only been notified that they have been placed on furlough and not explicitly consented to it?
- What about errors made by managers at divisional level within large companies? Will the company be liable for the off-piste approach of some local managers to claims?
- Will "back to work" aspects be handled correctly in a way that does not create Scheme liability?
- Have all payments been made on to the workers?
- What evidence is there that workers did not work while furloughed, for example, that sales staff really did not keep in touch with clients?
- Will the updated rules, allowing employers to use the workers part time and start paying National Insurance Contributions (NICs) and pension contributions on the furlough payments from August, and a proportion of the furlough payment from September, pose further uncertainty and risk?
Making employees redundant while on furlough
Unfortunately, it is likely that a large number of businesses will make employees redundant when they are on furlough leave, especially in the lead up to August when employers start having to fund NICs and pension contributions. Giving notice to an employee while on furlough will have a financial benefit, as furlough pay will count towards the notice pay that the business would have had to have paid in any event for employees. But, is it an abuse of the Scheme if the business was not performing anyway and had already been planning redundancies prior to the pandemic? Or, on the flip side, what if the business is in a relatively healthy financial position and could have afforded to pay all the notice pay without a furlough pay contribution? Will the public mood think this is fair? Will this place pressure on the government to take a firm line?
Will companies that have not been severely affected by Covid-19 start paying back grants?
This remains to be seen but the announcement this week from Andrew Neil, chairman of the Spectator magazine, may be a sign of things to come:
We have taken a financial hit but nothing as bad as I feared. We remain a profitable and growing company, now with strengthening cash flow. For that reason, we will return to the taxpayer the funds we took from government to finance our furlough scheme and withdraw from that scheme forthwith.
Does the well-connected and well-informed Mr Neil anticipate something about the direction of public policy in relation to furlough clawbacks?
In the US, in a further possible sign of things to come, more than 40 public companies are pledging to return money to the government's small business coronavirus fund now that US Treasury Secretary Steven Mnuchin is threatening criminal prosecutions for violating the rules of that programme.
What should you do now?
Obviously, it would seem unfair for HMRC to seek to clawback on the basis of some of the above, such as where the entitlement rules have just not been very clear. However, the government will need to raise money over the next few years. Attacking the use of the Scheme by businesses may seem less unpopular to the government than many of the alternatives, especially where relevant businesses are seen to have traded through the downturn relatively successfully. The government may effectively come to see this as a form of windfall tax.
Businesses should therefore review their records to ensure that they have detailed records of their decisions as to why they considered that they were entitled to access payments under the Scheme including evidencing the payment out of the grant.
Companies should also obtain and retain evidence that employees paid under the Scheme would still have been employed but for Covid-19.
The deadline of the first obligation to self-declare mistakes is 30 days after Royal Assent – which is normally in July. Companies should seek to carry out any review and make corrections to any grants before this date to avoid penalties. Directors are likely to need to reassure auditors and in some cases will need legal advice about how best to protect themselves from liabilities.
Companies should also put in writing to their employees the need to stop working while they are furloughed, and employees' eventual return to work will need to be managed carefully. Non-furloughed employees (especially senior ones) should also be clear on the restrictions around involving furloughed colleagues in work. Auditors or HMRC might ask to see information evidencing the employer's approach to compliance in the fullness of time.
Where local or divisional managers have implemented the Scheme in their areas of a business, spot-checks should be carried out as to how it has been applied, and records kept of those checks. Auditors may well need to see these. Particular care will be needed with NICs and pension contributions from August and employer contribution changes from September.
Directors who are not sure if their company qualifies or whether they have applied the grant properly should take legal advice – covered by privilege – about best options to rectify or build a defence.