Members Voluntary Liquidations: Company distributions and HMRC clearances
Susan Cattell gives details of HMRC’s standard response to clearance applications for company distributions in liquidations, following the introduction of a new anti-avoidance measure.
Distributions may be taxed as income
Some capital distributions after 5 April 2016 will be taxed as income to tackle perceived tax avoidance. The intention is to combat abusive Phoenixism and Moneyboxing but the changes are likely to have a much wider impact. ICAS responded to a consultation in February highlighting the additional complexity and unintended adverse consequences the change was likely to bring.
Some minor changes to the original proposals were made. However, one of ICAS’ key suggestions, the inclusion of a clearance mechanism, was rejected. Without the certainty of a clearance, some commercial transactions may be inhibited
Increased numbers of liquidations in March
The new rules came into effect in April. In March there was a surge in solvent liquidations: 2,663 compared to the previous record figure of 992 in April 2015 and the monthly average for the 12 months prior to March 2016 of 768. Some of the increase probably relates to the changes to dividend taxation (also effective from 6 April). Those being targeted by the new rules may also have contributed – but undoubtedly some of the additional liquidations will relate to genuine commercial liquidations (or liquidations triggered by proprietor retirements) brought forward to escape the uncertainty introduced by the new anti-avoidance rule. The legislation is now in force so how can those considering winding up their companies today gain some insight into HMRC’s views?
HMRC Guidance – coming later
In rejecting calls for a clearance mechanism for the TAAR the government stated that it would not be appropriate because “clearances are not generally provided for this type of anti-avoidance rule”. However, HMRC is to publish guidance, including examples, to demonstrate how the rule will be applied in practice. This guidance is not yet available but in the meantime, HMRC has been receiving clearance requests.
HMRC response to clearance requests
HMRC is not giving clearances but, in the absence of the guidance, HMRC have drafted a standard reply, which will be issued in response to requests for clearance. This does not replace the guidance but is intended to be useful until the guidance is available. It includes the following three examples to illustrate the operation of the condition relating to individuals carrying on the same or similar trades or activities in the two years following the distribution.
Mr A has been the sole shareholder of a company which carries on the trade of landscape gardening for ten years. Mr A decides to wind up the business and retire. Because he no longer needs a company he liquidates the company and receives a distribution in a winding up. To subsidise his pension, Mr A continues to do a small amount of gardening in his local village.
Conditions A to C are met, because gardening is a similar trade or activity to landscape gardening. However, when viewed as a whole, these arrangements do not appear to have tax as a main purpose. It is natural for Mr A to have wound up his company because it is no longer needed once the trade has ceased. Although Mr A continues to do some gardening, there is no reason why he would need a company for this, and it does not seem that he set the company up, wound it up and then continued a trade all with a view to receive the profits as capital rather than income. In these circumstances, Mr A’s distribution in the winding up will continue to be treated as capital.
Mrs B is an IT contractor. Whenever she receives a new contract, she sets up a limited company to carry out that contract. When the work is completed and the client has paid, Mrs B winds up the company and receives the profits as capital.
Again, conditions A to C are met because Mrs B has a new company which carries on the same or a similar trade to the previously wound up company. Here, though, it looks like there is a main purpose of obtaining a tax advantage. All of the contracts could have been operated through the same company, and apart from the tax savings it would seem that would have been the most sensible option for Mrs B. Where the distribution from the winding up is made on or after 6 April 2016, in these circumstances the distribution will be treated as a dividend and subject to income tax.
Mrs C is an accountant who has operated through a limited company for three years. She decides that the risk involved with running her own business is not worth her effort, and so decides to accept a job at her brother’s accountancy firm as an employee. Her brother’s firm has been operating for eight years. Mrs C winds up her company and begins life as an employee.
Conditions A to C are met because Mrs C is continuing a similar activity to the trade that was carried on by the company. She is continuing it as an employee of a connected party, triggering Condition C. But looking at the arrangements as a whole it is not reasonable to assume that they have tax advantage as a main purpose, so Condition D will not be met.
Mrs C’s company was incorporated and wound up for commercial, not tax, reasons; although she works for a connected party it is clear that the other business was not set up to facilitate a tax advantage because it has been operating for some time. In these circumstances, the distribution from the winding up will continue to be treated as capital, absent any other considerations.
ICAS continues to oppose legislation which requires extensive guidance from HMRC, so that taxpayers are left in the unsatisfactory position of being taxed by legislation but untaxed by guidance. The legislation itself should provide clarity. Please send any examples of problems or other comments around this legislation to firstname.lastname@example.org