Be Certain on Winding-up

Proposed legislation will make PSCs think before closing down their company

Draft legislation, to be introduced from 6th April 2016, will reclassify the disposal of shares on the winding-up of a close company as a dividend rather than a capital gain, providing certain conditions are met. This follows the announcement, at this year’s Budget, that the government would publish a consultation on company distribution rules. This consultation is now being published.

Who will be affected?

Those affected will be some shareholders of close companies who receive a payment from the company which is taxed as a capital gain instead of as income, where the purpose of the transaction (or one of the main purposes) is to obtain a tax advantage.

Overview

The measure will strengthen the Transactions in Securities rules, which are designed to prevent a tax advantage from being obtained where a transaction is carried out; where a main purpose, or one of the main purposes, of a party to the transaction is to obtain a tax advantage.

It will also introduce a new Targeted Anti-Avoidance Rule, which will apply to distributions in a winding-up where certain conditions are met.

The draft legislation will accompany a consultation which will discuss the distributions legislation more broadly.

This measure will restrict the opportunities for shareholders to convert to capital what might otherwise be paid as an income distribution (most commonly a dividend). In particular, the government wish to disincentivize this type of behaviour which will increase from 6th April 2016 when changes are made to the way in which dividends are taxed.

Currently, where a contractor dissolves their company, the final distribution, which is usually the cash held by the company, can be treated as a capital gain rather than a dividend. This is particularly advantageous if the shares held in the PSC qualify for Entrepreneurs’ Relief which reduces the Capital Gains Tax (CGT) charge to 10% rather than 18% (basic rate taxpayer) or 28% (higher rate taxpayer). The added attraction of the first £11,100 of any gain being tax free makes the CGT route even more appealing.

Targeted Anti-Avoidance Rule (TAAR)

A new 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:

1. 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
2. within a period of two years after the distribution, S continues to be involved in a similar trade or activity
3. the circumstances surrounding the winding-up have the main purpose, or one of the main purposes, of obtaining a tax advantage

The rule will not apply where the only asset distributed during the winding-up is shares in, or securities of, a company which is a subsidiary of the wound-up company.

For those contractors who close their company’s down with a view to retirement or taking up employment elsewhere, then these proposals will not affect them and they can take the CGT treatment without fear of the decision coming back to haunt them. Those freelancers, however, who favour shutting their company down and forming another soon after, primarily to circumvent an IR35 enquiry, will have to re-think their strategy unless they are happy to accept the dividend tax treatment as a natural consequence of their decision making.

Carrying on the same business in a different guise, such as a sole trader, partnership or LLP, within two years of the final distribution will not work either.

Contractors will therefore need to be certain of their intentions, for at least the following two years, when winding-up their PSC if they want to benefit from the CGT treatment to the final distribution.