In this second of a two-part article, we continue our look at anti-avoidance provisions aimed at tax-driven ‘phoenixism’ with the following example.
Example: Winding down
Jessie has worked for over twenty years as a freelance radio presenter and ‘disc jockey’.
For the past twenty or so years, Jessie has run these activities through her 100% owned limited company, Ruskin (41) Ltd. Jessie has 100 £1 ordinary shares in Ruskin (41) Ltd, which were issued at par. She regularly draws a salary of around £20,000 and an annual dividend of £50,000 from Ruskin (41) Ltd. She has no other income or major outgoings.
Jessie is now approaching 70 and wishes to retire from her radio work by the end of 2016, and is contemplating winding-up her company. However, she wants to continue with her ‘private’ DJ work at parties and weddings etc., albeit on a scaled-down basis reducing to about two bookings per month.
Ruskin (41) Ltd has a bank balance of about £660,000 and distributable reserves of around £730,000.
Tax analysis
As discussed in part 1 of this article, the new ‘anti-phoenix’ TAAR (targeted anti-avoidance rule) seeks to counteract company liquidations that are driven by tax-engineered ‘phoenixism’. These are seen by HMRC as contrived arrangements by (close company) shareholders to extract the company’s distributable profits without paying dividend income tax rates. In 2016/17, the income tax rates for sizeable dividends are 32.5% (between £32,000 and £150,000) and 38.1% (above £150,000). On the other hand, if the same amounts were received as capital distributions with the benefit of entrepreneurs’ relief (ER), they would only be taxed at 10%.
Since Jessie plans to carry on some DJ work as a sole trader (and this activity has previously been carried on by Ruskin (41) Ltd), she might be vulnerable to an income tax dividend charge on her liquidation proceeds under the anti-phoenix TAAR in ITTOIA 2005, s 396B.
However, having regard to all of the circumstances, it is reasonable to take the view that Jessie has effectively retired from her mainstream work and that the liquidation of ’her’ company is not mainly motivated by the avoidance or reduction of income tax. Taking into account HMRC recent guidance examples (see www.ion.icaew.com/taxfaculty/b/weblog/posts/distributions-in-a-winding-up), looking at the arrangements as a whole, it would sensible for Jessie to liquidate ‘her’ company and continue her interest in DJ work on a relatively small scale as a sole trader.
Jessie should therefore have a robust case for reporting her capital distribution(s) received on the liquidation as capital gains, taxed at the ER CGT rate of 10%.
Given the amounts involved, Jessie must close her company down under a formal voluntary members’ liquidation, and hence some liquidation costs will be incurred. On the other hand, it would be disastrous to strike the company off (under CA 2006, s 1003). This is because, unless the amounts distributed prior to dissolution are less than £25,000, they will be treated as income distributions (under CTA 2010, s 1030A).
It might also be prudent for her to seek a non-statutory clearance from HMRC to confirm that Ruskin (41) Ltd qualifies as a trading company for ER purposes in the twelve months before the trade ceases, notwithstanding the company’s substantial cash balance.
Since distributions made in the course of a winding-up are now firmly within the scope of the transactions in securities legislation, Jessie might consider applying for an advance clearance (under ITA 2007, s 701) to obtain comfort that HMRC would not seek to counter the liquidation distributions (under ITA 2007, ss 684 and 689). Provided HMRC gave clearance under ITA 2007, s 701, this would suggest that the liquidation of Ruskin (41) Ltd was not driven by income tax avoidance, which would strengthen Jessie’s defence against any subsequent attempt by HMRC to invoke the TAAR.
Practical Tip:
Where significant amounts are being distributed on the closure of the company, the shareholders must formally liquidate it to obtain capital gains treatment (and avoid the temptation to use the ‘dissolution’ route under the Companies Act 2006).
