Blog 2 –
Payments made to shareholders are deemed to be distributions and taxed as income. Payments made to shareholders under liquidation are not distributions rather being taxed as a capital gains tax disposal of an interest in shares. This will be the case so long as the company has been liquidated for genuine commercial reasons (e.g. cessation of the business or following the sale of the trade and assets to another entity that is under substantially different control) and particularly where the liquidation is not motivated for tax reasons.
However in recent years, the beneficial CGT treatment has led to an increased use of tax-driven ‘phoenix’ arrangements whereby a company is liquidated, shareholders withdraw profits receiving a capital distribution (often enabling a claim to CGT entrepreneurs’ relief taking the tax rate down to 10%) and then the shareholder sets up another company in a similar field and the process is repeated.
The Finance Bill 2016 introduced the Targeted Anti Avoidance Rules (TAAR) to counter this practice and tax the distribution as income rather than a capital gain should four conditions apply:
- Condition A: the shareholder held at least 5% of the shares in the company immediately before the liquidation
- Condition B: the company was a close company at some point during the two years ending with the liquidation
- Condition C: the shareholder continues or is involved with, the carrying on of the same or a similar trade within two years following the date of the distribution
- Condition D: it is reasonable to assume that the main purpose (or one of the main purposes) of the winding up was the avoidance or reduction of income tax
Condition D is assessed by reference to intentions at the time that the decision was made to wind up the company. HMRC will also treat events occurring after the winding up as evidence and will want to look at all available evidence when assessing the main purpose.
Condition C has proved to be the main restricting condition not least due to the lack of clarity from HMRC. However, HMRC have become aware of schemes that have been devised whereby promoters claim to counter Condition C and in the past year have issued updates to its guidance on the TAAR in its Company Taxation Manual and last month published “Spotlight 47” entitled “Attempts to avoid an Income Tax charge when a company is wound up”. “Spotlight 47” acknowledges that such schemes claim to circumvent the TAAR legislation by artificially modifying those arrangements which the rules target. An example would involve the selling of a company to a third-party company rather than liquidating. The third-party company pays for the target company by receiving a dividend from the target company; the individual shareholder carries on trading but using a different vehicle. The idea is supposed to work on the basis that no liquidation has taken place (and therefore ‘phoenixing legislation’ is not in point) and also because the transactions in securities legislation does not apply because the sale is to a third party.
HMRC consider that these schemes do not work, and as well as quoting the TAAR rules have confirmed that they will consider whether the General Anti-Abuse Rules apply, which could result in a 60% penalty. “Spotlight” states that for arrangements entered into on or after 16 November 2017, HMRC will also consider whether an ‘enablers’ penalty could be applied to anyone who has enabled the use of this type of scheme. The penalty amount will be equal to the amount of consideration received for enabling the arrangements. The user of the scheme may also be subject to penalties for filing an inaccurate return, with penalties of up to 100% of the undeclared tax.