Bankruptcy is one way the law deals with people unable to pay their debts. Following an order of bankruptcy, a Trustee is appointed who takes possession of your assets towards payment of your debts fairly between your creditors, according to certain rules. Bankruptcy also imposes a number of restrictions on what you can do. For detailed information on bankruptcy obtain advice from an adviser from the list of contacts in section 11 of this guide. Being made bankrupt by HMRC is broadly similar to being made bankrupt by a commercial creditor, but you will need to be aware of the following additional factors.

If you owe HM Revenue and Customs more than £2,000 – and the local recovery office has been unable to reach an agreement with you or to enforce payment by distraint or a CCJ – then your file may be passed to HM Revenue and Customs’ Enforcement Offices (EIS) for consideration of bankruptcy proceedings.

What happens when your file reaches the Enforcement Office?

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

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

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

Very occasionally the Enforcement Office may decide not to take further action against a person who is unable to pay. This might apply where you have no assets and a low income, and your situation is unlikely to change in the future because you are older or suffering from long-term poor health.

The statutory demand

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

By law you may apply to have a statutory demand from any creditor “set aside”, for example because the amount demanded is not due, but in tax cases such an application is unlikely to be successful. This is because the certificates produced by HMRC, stating that tax has been charged and has not been paid, must be accepted by the court as sufficient evidence that the tax is due.

The bankruptcy petition

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

The petition gives details of the tax due and tells you the date and time when the case will be heard at the Bankruptcy Court.

The bankruptcy hearing

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

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

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

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

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

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

Bankruptcy is good for some people

Although the term “bankruptcy” may sound negative, it can sometimes help a person who is hopelessly insolvent and needs a fresh start. You need to weigh the “downsides” of bankruptcy against the possible advantages.

The main advantages of bankruptcy are that:

• when you are discharged from bankruptcy – normally after one year – income tax and other debts are written off (apart from maintenance obligations, parking fines and student loans)
• your creditors may no longer contact you about your debts

The main downsides are that:

• you may lose valuable assets such as equity in your home, investments and valuable private possessions
• until you are discharged you are prohibited from certain jobs – e.g. being a company director, lawyer, chartered accountant, or justice of the peace
• until discharge, you may not seek credit of more than £500 without declaring you are bankrupt
• you may have to make payments out of your  income for the benefit of your creditors for up to 3 years
• your bankruptcy is published in the London Gazette and people who know you personally may become aware of it, which may be embarrassing.

While many people would not want to accept these disadvantages, they may not matter much to you if you have little of value and are in a job that is not prohibited. Your home is unlikely to be at risk if it is rented, or you own a property with negative equity. If so, you may not mind HMRC petitioning for your bankruptcy.

Indeed, you may decide to speed things up by presenting a “debtor’s petition” for bankruptcy, although in this case you would have to pay a deposit of £525 towards the costs of administering your bankruptcy, and a court fee of £175 (which is waived for people on income support and certain other benefits).

Debt relief orders

If you have worrying debts but can’t raise the money for a debtor’s petition for bankruptcy, then you may want to apply for a debt relief order (DRO). This procedure was introduced in 2009 to help people in England and Wales who owe relatively little money, have little or no disposable income and no assets to repay what they owe, but cannot afford to make themselves bankrupt. A similar scheme exists in Scotland, the Low Income Low Asset (LILA) bankruptcy (see the Accountant in Bankruptcy website).

DROs cost £90 and are administered by “authorised intermediaries” (many of whom are advisers in Citizens Advice Bureaux), and the main requirements are that:

• you are unable to pay your debts

• you owe up to a maximum of £15,000

• your total gross assets do not exceed £300

• after taking away tax, national insurance contributions and normal household expenses, your disposable income is no more than £50 a month.

There is more guidance on DROs in ‘Guide to Debt Relief Orders’ published by the Insolvency Service, which may be downloaded from  insolvency service.

But do get independent advice

Petitioning for bankruptcy or a DRO is a serious step – with possible pitfalls depending on your situation – and so it is important that you get good independent advice before going ahead.

This could be obtained from a money adviser in a Citizens Advice Bureau or other voluntary organisation, or from a registered insolvency practitioner. You may also want to review the resources mentioned on page 27.

Individual voluntary arrangements

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

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

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

Nevertheless, it is worth exploring whether you might be able to propose an IVA which might be acceptable to at least 75% of your creditors. Most insolvency practitioners will be happy to have a short meeting with you – without making any charge – to consider whether this is possible. However, it can be difficult to obtain HMRC’sagreement to an IVA. In practice about half the proposals submitted are likely to be rejected by HMRC.