Distributions and members voluntary winding up - update
Back in February, we considered changes to the rules on distributions when there is a Members Voluntary Winding up.
Since the 2016 Budget, there have been some modifications to the draft rules. These could yet change before the Finance Bill receives Royal Assent later this year.
The changes in context
New targeted anti-avoidance rules in the Finance (no 2) Bill 2016 are designed to combat Phoenixism and Moneyboxing, but may have wider impact, especially where cash-rich companies are put into MVL prior to retirement, or partial retirement of shareholder directors.
From 6 April 2016, shareholders in close companies face distributions being charged to income tax, where the liquidation is considered to be tax-motivated and the director returns to work in a similar line of business, be it as a company director, partner or sole trader within two years.
This raises serious issues for practitioners where a client might inadvertently return to a business activity similar to one which they have left.
Scope of the charge
The anti-avoidance rules apply where a distribution is made to an individual in respect of share capital in a winding up (per new section 396B ITTOI 2005 for UK resident companies; s404A ITTOIA 2005 for non-resident companies), where conditions A-D apply as outlined below. The only exceptions are (per s396B (7) where the amount of the distribution would not result in a gain for CGT purposes, or where it is a distribution of irredeemable shares.
Note the rules regarding distributions in respect of share capital, in anticipation of a company being struck off, are unaffected (section 1030A Corporation Tax Act 2010). The £25,000 limit on distributions under 1030A (5) (b) still applies.
What is new?
Following the 2016 Budget, there have been some minor changes to the original draft. We now have four conditions (A-D) rather than three (A-C).
Finance (no 2) Bill 2016 - clause 35 (replacing draft clause18 in the post Autumn Statement version) now includes a relaxation of the rules: individuals will need to have at least a 5% interest in a close company; previously any shareholder could be affected (new condition A).
New condition B (which was condition A in the original) confirms application to any company which is a close company, or was such within the two years prior to the winding up
Return to a similar trade
Condition C concerns re-entry to a similar trade within two years of the distribution. The scope here is now extended to 51% subsidiaries.
So the new version reads:
Condition C - at any time within a two-year period after the distribution:
- a) the individual carries on a trade or activity which is the same as, or similar to, that carried on by the company, or a 51% subsidiary of the company
- b) the individual is a partner in a partnership which carries on such a trade or activity
- c) the individual, or a person connected with him or her, is a participator in a company in which he or she has at least a 5% interest and which at that time –
- i) carries on such a trade or activity, or
- ii) is connected with a company which carries on such a trade or activity, or
- d) the individual is involved with the carrying on of such a trade or activity by a person connected with the individual.
The tax motive clause
Condition D applies a tax motive test:
It is reasonable to assume, having regards to all the circumstances, that –
- a) the main purpose or one of the main purposes of the winding up is the avoidance or reduction of a charge to income tax, or
- b) the winding up forms part of arrangements the main purpose or one of the main purposes of which is the avoidance or reduction of a charge to income tax
An uncertain horizon
Hindsight is a useful tool; but it can be expensive. With complex tax rules, it is imperative that clients fully understand the potential consequences of future actions. Returning to work in a similar field means that a condition D could come into play up to two years after the original distribution.
Clearly it is best now to take an objective look now at the worst case scenario and consider how HMRC might view the transaction. Does it avoid any taint of tax-motivated behaviour?