Budget confirms company distributions changes
In December 2015, HMRC published the consultation document ‘Company distributions’. That consultation closed on 3rd February 2016 and despite the government not yet having published its responses to the consultation, this did not stop George Osborne from announcing in last week’s Budget that the proposed legislative changes to company wind-ups will go ahead in Finance Bill 2016.
The legislation itself is a set of income tax avoidance rules aimed to stop shareholders of close companies turning income into capital so as to pay Capital Gains Tax (CGT) rather than Income Tax and thereby make a substantial saving of tax.
Income v Capital
It is because the income/capital divide is still very much an issue that tax planning in this area thrives. A contractor whose company is a trading company and qualifies for Entrepreneurs’ Relief, will pay CGT at a rate of 10% on winding up of their company and extracting all of its reserves, as opposed to 7.5%, 32.5% or even 38.1% – the ordinary, upper and additional dividend tax rates effective from 6th April 2016.
Transactions in Securities
Under ‘Transactions in Securities’ anti-avoidance rules, which have been around since 1960, it was arguable that winding up a company simply to take out its assets on a CGT basis rather than as dividends, was already within the anti-avoidance rules. Where the rules applied then the company’s reserves could be taxed as if they had been paid out as a dividend, i.e. at the shareholders’ marginal rate of Income Tax.
HMRC therefore already had a weapon at its disposal to prevent the more aggressive attempts to turn income into capital. Whilst ordinary and legitimate commercial liquidations were not caught by these provisions, the Revenue used them to counteract persistent attempts to extract money as quasi-dividends which were liable to CGT.
Finance Bill 2016 will change the procedural rules for Transactions in Securities so that they operate in a similar fashion to the Self Assessment compliance rules. This will then empower HMRC to launch enquiries in the same way as they now do under Self Assessment.
Phoenixism
This is where the new legislation that will cause the most problems to those contractors who are in the habit of closing down their companies and forming new ones on a regular basis, as a new Targeted Anti-Avoidance Rule (TAAR) will be introduced that will treat a distribution from a winding-up as if it were an income distribution where certain conditions are met:
- an individual (S) who is a shareholder in a close company (C) receives from C a distribution in respect of shares in a winding-up
- within a period of two years after the distribution, S continues to be involved in a similar trade or activity
- the circumstances surrounding the winding-up have the main purpose, or one of the main purposes, of obtaining a tax advantage
Carrying on the same business via a different business vehicle, such as sole trader, partnership or LLP, within two years of the final distribution will not circumvent the new rules.
It is my understanding that, to date, HMRC has no plans to provide an official clearance procedure within the new rules. So, you’re on your own again. Thanks for the help!
Have these TAAR rules come into play?
I was planning to shut down my company and form a similar company with two colleges.