'Phoenixing’ And The Targeted Anti-Avoidance Rule – Where Are We Now?

Lee Sharpe looks at HMRC’s recently-updated guidance on the ‘anti-phoenixing’ legislation introduced in Finance Act 2016. 

 

Finance Act 2016 introduced a targeted anti-avoidance rule (TAAR), which was designed to remove the personal tax break for ‘phoenixing’ companies – that is, deliberately winding a company up and starting again with a fresh company doing basically the same as before.  

 

This tax break arises because the funds distributed on a winding up may be deemed either as a dividend or as a capital gain, with the former option costing as much as around four times the latter, when comparing the top rate of income tax on dividends (38.1%) with that on capital gains potentially eligible for entrepreneurs’ relief and a reduced rate of capital gains tax (CGT) (as little as 10%). Unsurprisingly, most phoenixing operations seek to exploit the comparatively generous CGT exit route. 

 

Having arranged the tax regime in such a way (and presumably by design rather than by accident), the government decided that such a difference could be abused, so set about cobbling together something to deter taxpayers from taking advantage of the regime it had created (I have said before that the government creates most of the tax avoidance it complains about, and this is a classic example). 

 

The TAAR (at ITTOIA 2005, s 396B) works to re-designate a distribution that would otherwise satisfy the criteria for CGT treatment, as income, for actions taken up to two years after the distribution was made.  

 

Very simply, where an individual has at least a 5% interest in a ‘close’ company (basically one with five or fewer shareholders) and receives a distribution on the winding up of the company, if: 

then the distribution will be re-categorised as a dividend, subject retrospectively to income tax instead of CGT. 

 

The legislation itself is more widely drawn and, amongst other things, captures groups of companies and broad arrangements involving a winding-up.  

 

There is much to dislike about a piece of legislation that: 

The profession was quite concerned about this new TAAR when it was introduced – but not as concerned as HMRC was when the profession then suggested that a pre-transaction clearance regime would, of course, be required, which would then need to be staffed by real people at HMRC.  

 

Guidance was promised instead – see HMRC’s Corporation Tax manual at CTM36300 (published more than a year after the TAAR went live). It was not very good. That guidance has recently been updated and expanded – usefully – so that it is…better.  

 

Updated guidance 

It is ‘Condition D’ of the legislation that is arguably the most problematic when it comes to evaluating whether or not the TAAR may be triggered; simply put, was it done to avoid or reduce income tax?  

 

In this regard, HMRC’s guidance (at CTM36340) now includes several new paragraphs, shedding further light on HMRC’s position. In summary, these include: 

 

Confirmation that a company’s decision not to make a distribution prior to a winding-up cannot be inferred, on its own, to mean that its shareholders, etc., intended to avoid income tax, such that Condition D is met automatically.  

Under the aegis of self-assessment, it is for the individual to determine whether or not tax avoidance was a main purpose of the winding up. HMRC can displace this approach only where the individual’s decision is not reasonable. 

It follows that it is for HMRC to demonstrate that the taxpayer’s assessment of the event was not reasonable, rather than for the taxpayer to prove that they were; in other words, the onus is on HMRC.  

The test is in relation to the taxpayer’s intentions at the time of the winding up of the company, rather than two years later. It will, of course, be open to HMRC to review the facts in light of subsequent events and to draw appropriate conclusions therefrom. For example, the guidance states: ‘if the intention is that the taxpayer retires completely when the winding up occurs but is within two years offered, and accepts, a position in the same trade, HMRC will want to look at the evidence that the offer was unsolicited’. Well, HMRC can always ask…two years is plenty of time to have a change of heart in relation to retirement – or an unexpected change in circumstances.  

 

Bearing in mind HMRC has only just said that it is for their inspectors effectively to prove that the taxpayer intended at the time of winding up the previous company to avoid or reduce their income tax bill, it is perhaps disappointing that it takes only a few more lines of guidance before HMRC is expecting the taxpayer to prove a job offer in the same/similar field was unsolicited. ‘Plus ca change’, and all that. 

 

The guidance is undoubtedly useful, and the update is definitely a step or two in the right direction, but the Chartered Institute of Taxation and other professional bodies were, in my opinion, right to be concerned about this legislation, which relies heavily on HMRC’s interpretation as to the practicalities of that two-year open period following the winding up of the company. There is a real risk that, unfettered, it could stifle genuine entrepreneurialism.  

 

Perhaps most annoying about the whole affair is that HMRC were sure that the TAAR would be invoked only rarely, and that that the vast majority of distributions from a winding-up were expected to continue to be treated as capital. The cynic in me reflects that this assurance was given only because HMRC was panicked into explaining why a formal pre-transaction clearance regime was not necessary; the fact that HMRC has subsequently ignored several suggestions to include that assurance in its manuals does nothing to assuage that fear.