HMRC warning on schemes claiming to avoid income tax when a company is wound up
Susan Cattell explains why practitioners should make sure they are aware of Spotlight 47.
Targeted anti-avoidance rule: distributions in a winding up
Finance Act 2016 introduced a new targeted anti-avoidance rule (TAAR) intended to tackle avoidance (particularly phoenixism) by reclassifying some distributions, which would have been capital distributions in a winding up, as income distributions. The new rule (s396B ITTOIA 20015) took effect for distributions made on or after 6 April 2016.
Conditions for the TAAR to apply
A distribution made to an individual in a winding up will be treated as income rather than capital where four conditions are met:
- Condition A: The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up;
- Condition B: the company was a close company at any point in the two years ending with the start of the winding up;
- Condition C: the individual receiving the distribution continues to carry on, or be involved with, the same trade or a trade similar to that of the wound up company at any time within two years from the date of the distribution; and
- Condition D: it is reasonable to assume that the main purpose or one of the main purposes of the winding up is the avoidance or reduction of a charge to income tax.
HMRC was slow to issue guidance on the TAAR but it was eventually included in the Company Taxation Manual.
HMRC issues Spotlights to warn potential users about tax avoidance schemes. Spotlight 47, published on 4 February 2019, highlights schemes “that claim to avoid the Income Tax charge for shareholders when winding up a company.” According to the Spotlight, the promoters claim that the schemes get around the TAAR legislation. For example, “they claim that by making an artificial modification of the arrangements aimed at defeating the intention of the legislation (by selling the company to a third party rather than winding it up, for example) the TAAR will not apply.”
HMRC’s view is that these schemes do not work because:
- in many cases, the actual outcome is that the individual is receiving distributions in a winding up - as the individual carries on trading using a different vehicle these schemes are within the scope and purpose of the TAAR legislation;
- phoenixism arrangements that claim to involve payments to shareholders taxed as capital instead of income are caught by the TAAR, or other provisions.
HMRC goes on to say that it will investigate any attempts to avoid the income tax charge.
GAAR and enablers penalties
Practitioners should note that HMRC also say that where it is claimed that the TAAR does not cover the arrangements, HMRC will consider whether the General Anti-abuse Rule (GAAR) applies to the schemes. Transactions after 14 September 2016 where the GAAR applies will be subject to a 60% user penalty.
HMRC will also be considering (for arrangements entered into on or after 16 November 2017) whether an enablers penalty can be applied to anyone who has enabled the use of this type of scheme. The penalty amount will be equal to the amount of consideration received for enabling the arrangements. The user of the scheme may also be subject to penalties for filing an inaccurate return, with penalties of up to 100% of the undeclared tax.
Professional Conduct in Relation to Taxation (PCRT)
The current version of PCRT (effective from March 2017) includes the standards on tax planning which members of the main professional bodies (including ICAS) should adhere to. The issue of a Spotlight will be relevant in the context of these standards; Spotlight 47 should, therefore, be considered by practitioners who may come across schemes aimed at bypassing the TAAR on distributions in a winding up.