Few would quarrel with measures to deter ‘phoenixism’ where a company is wound up and the shareholders receive capital distributions, which are liable to capital gains tax (at only 10% with entrepreneurs’ relief). A new company is then formed with the same members as the defunct company. But the new targeted anti-avoidance rule (TAAR) may potentially apply where no tax avoidance is intended.
It has always been difficult to extract profits from a company in a form which is not liable to income tax either as dividends or remuneration (with the latter also liable to National Insurance contributions). Loans to shareholders have tax consequences for the company, and if the loan is written off this is also taxed as a dividend. The exception is distributions received in the course of winding up a company, which are specifically excluded from being distributions (within CTA 2010, s 1000: ‘Meaning of ‘distribution’) by s 1030 (‘Distribution in respect of share capital in a winding up’). They are therefore always capital distributions – or were.
The TAAR
Finance Act 2016 introduced the new s 396B (‘Distributions in a winding-up’) into ITTOIA 2005, Pt 4, Ch 3 (‘Dividends and other distributions from UK resident companies’), with effect from 6 April 2016. This states that:
‘1) For the purposes of this Chapter, a distribution made to an individual in respect of share capital in the winding up of a UK resident company is a distribution of the company if-
(a) Conditions A to D are met, and
(b) the distribution is not excluded …’
In other words, if the TAAR applies, then instead of being taxed as a capital distribution (enabling entrepreneurs’ relief to be claimed if the conditions for relief are met), the distribution is liable to income tax in the same way as a dividend.
Conditions A to D
The conditions (A to D, slightly abbreviated) are as follows:
A. the shareholder’s interest in the company is at least 5% (see below).
B. The company is a ‘close’ company.
C. Within two years beginning with the receipt of the distribution in winding up:
(a) the individual carries on a similar business either as a sole trader or in partnership;
(b) the individual or a person connected with him has an interest of at least 5% in a company that carries on a similar business, or is connected with such a company; or
(c) the individual is involved with a similar business carried on by a person connected with him.
D. It is reasonable to suppose having regard to all the circumstances that a main purpose of the winding up is the avoidance of income tax or is part of arrangements, a main purpose of which is to avoid income tax.
References to a 5% interest are to holding 5% or more of the company’s ordinary shares and voting rights.
Conditions A and B are, of course, simple questions of fact. Condition C is more difficult. As an incentive to disincorporation, Finance Act 2013 introduced legislation (TCGA 1992, ss 162B-162C) to enable assets to be transferred from the company to the shareholders without a corporation tax charge arising. But s 396B could potentially apply in such circumstances, especially if the company has considerable cash reserves.
Similarly, it is not uncommon for family members to be involved in similar types of business independently of each other. So if, say, father winds up his joinery company but son also owns a joinery company, Condition C(b) would be met. It goes further than that even. If son’s company’s business is not similar to his father’s, but his company is connected with another company which does carry on a similar business, then Condition C(b) is also met.
The concept of being involved in a similar business for the purposes of Condition C(c) could include ‘working as an employee of a spouse in a similar trade’ according to HMRC, which presumably is unincorporated or C(b) would apply.
The definition of ‘connected’ is by reference to ITA 2007, s 993, which is very widely drawn.
However, Conditions A to D all have to be met, so much hinges on whether it is ‘reasonable to suppose’ that tax avoidance was a main purpose of the winding up. Now the people at whom these provisions are aimed must presumably know who they are and will also know, or be advised, that if they attempt to avoid income tax in this way, they are stymied (absent any ‘cunning plan’).
For other individuals, any continuing association with a similar type of business, whether as a sole trader/partner, by virtue of a connected person’s company interests, or through other ‘involvement,’ is likely to mean that Conditions A to C are met, so whether s 396 applies will depend upon the ‘reasonable to suppose’ test.
Clearance and self-assessment
No clearance procedure (statutory or otherwise) is offered for the purposes of s 396B. HMRC say that they do not give clearances on whether an ‘only or main purpose’ test is or is not met, as the taxpayer will know what the main purposes behind their actions were.
A legitimate question which occurs is: ‘how on earth do HMRC expect to be able to police this?’ Ignorance of the law may be no excuse, but it may not even be possible for a taxpayer to know if Conditions A to C are met, since they may not know what company interests may be held by connected persons or what the activities or those companies might be – though in that case it seems highly unlikely that Condition D would be met.
However, in the absence of a clearance procedure the onus will be on the taxpayer to self-assess in line with the TAAR, and of course the circumstances which trigger the application of Condition C may not be known at the time the return is filed or even within the window for amendment. Failure to self-assess correctly (as HMRC see it) may presumably lead to penalties.
On enquiry, HMRC must apply the somewhat subjective test of whether it is ‘reasonable to suppose’ that the taxpayers had a ‘main purpose’ of avoidance of tax. What the taxpayer’s purposes were of course cannot be proved, and must be inferred having regard to the circumstances, and it is also difficult to see how HMRC will discharge the burden of proof that failure to disclose a receipt in line with the TAAR was ‘careless or deliberate’, unless blatant phoenixism is involved.
HMRC have received requests for clearance under the TAAR, but as noted their stance is that they do not give clearances where an ‘only or main purpose’ test is involved. They have published a standard letter responding to such requests, which gives three examples of where the legislation would or would not apply, which may be downloaded from the ICAEW website.
More comprehensive guidance is expected by the end of the year, though it is highly unsatisfactory: (a) that the application of the legislation should become largely a matter of HMRC practice; and (b) that unless the circumstances match the examples in the guidance, the taxpayer will be left with uncertainty as to whether or not the TAAR will apply. The professional bodies are therefore rightly concerned that the new legislation will lead to unintended consequences, and that businesses carrying out some commercial transactions will face unnecessary uncertainty because of a lack of clarity regarding the widely drawn TAAR.
Practical Tip:
The absence of a clearance procedure for the new TAAR will inevitably leave some taxpayers with uncertainty as to how to complete their self-assessment returns in relation to distributions in winding up received on or after 6 April 2016, especially since as noted the circumstances which trigger Condition C may not have occurred by the date the return is filed. The ‘elephant test’ will apply in many cases, and taxpayers will be able to compare their own circumstances to the examples in the expected further guidance. Otherwise, it may be necessary to disclose the facts and the reasons for the treatment adopted as additional information.
