When it comes to tax planning, if it seems too good to be true, it usually will be! This month's Tax Clinic deals with an idea to extract profits from a company at Capital Gains Tax rates, rather than the higher rate of income tax applicable to salary or dividends.
 Mark McLaughlin
This month's Tax Clinic query deals with a tax planning proposal involving the sale of a company to another company with the same shareholder. Major changes were made to Capital Gains Tax (CGT) from 6 April 2008. Perhaps the most significant changes were the abolition of taper relief and indexation allowance for individuals, and the introduction of a single CGT rate of 18% and entrepreneurs' relief. For disposals before 6 April 2008, maximum business asset taper relief reduces the effective CGT rate for higher rate taxpayers to around 10%. From 6 April 2008, entrepreneurs' relief reduces the effective CGT rate to 10% on the first £1 million of chargeable gains if the various relief conditions are satisfied. Even if no CGT relief is due, the standard CGT rate of 18% is lower than the 20% basic rate or 40% higher rate of income tax. For owner-managed or family companies, it will generally be more attracive for shareholders who are higher rate taxpayers to extract profits from the company as capital receipts, rather than as salary or dividends. A common situation where profits can be extracted in capital form is if the company is being liquidated when it has come to the end of its useful life. In addition, a sale of shares normally allows the shareholder to realise the value of shares in a capital form. However, there are anti-avoidance rules that can apply to 'transactions in securities' (e.g. shares) in artifical or non-commercial circumstances if an income tax advantage is obtained. The provisions can have the effect of cancelling out tax savings arising from certain share transactions involving closely managed companies. Those tax savings could arise on some share disposals where the CGT is lower than the income tax that a shareholder would pay on a dividend from the company. The 'transactions in securities' rules are widely drawn and relatively complex. Professional advice should be sought on whether the particular transaction is potentially caught by those rules. Query from TaxationWeb visitor ('mano786') Scenario: Mr A owns 100% of Company 1. He sets up company 2, being 100% owner of that also. Then sells shares of Company 1 (at market value of £300k) to Company 2 - realising capital disposal on him personally. Idea is basically to get the capital treatment on the £300k. Company 2 has no cash to pay for the shares so is shown as money due to Mr A on his director's loan account. Company 1 pays dividend to Company 2 - no tax implications of this I think - Company 2 now has cash to pay off Mr X on his director's loan account. This way Mr X got his hands on the £300k paying only 10% under CGT and not 25% if taken as dividend. Surely too good to be true??!! Are there any restrictions to the above - such as anti-avoidance rules? Any comments will be greatly appreciated. Editor’s Comments'mano786'suspects that this planning idea might be caught by anti-avoidance rules, and he is probably correct. The 'transactions in securities' rules are contained in the Income Tax Act 2007 at Part 13, Chapter 1. There is tax case law to support the view that HMRC would probably challenge the share disposal in the query based on the income tax anti-avoidance rules. There is an exception under those provisions, broadly if the transaction is for bona fide commercial reasons and obtaining an income tax advantage is not a main object of the transaction(s). There is a clearance application procedure available, whereby HMRC will state whether they consider the anti-avoidance provisions apply in the particular circumstances. In this case, the share disposal appears to be taking place in order to secure a lower tax bill, and thus on the face of it is potentially subject to the 'transactions in securities' rules. As mentioned, professional advice and assistance is strongly recommended in such circumstances, in advance of the transaction taking place. Forum responses included those reproduced below. 'ingrey' commented:It's a beautiful plan apart from the fact that it is wide open to attack from section 698 ITA 2007 - transactions in securities, which taxes such an arrangement as a dividend if one of the main purposes is to secure a tax advantage. Normally you would need to seek advance clearance from HMRC to ensure the anti-avidance legislation does not apply. PS don't forget stamp duty and also you might a need properly drafted purchase contract. 'wamstax' commented:The anti avoidance legislation will treat it as a dividend (wow quite a bill at 32.5%) on the net dividend of £300K. Clearly you have not sought approval from HMRC and must make a report of the incorrect treatment once the client goes through with this ill-conceived plan after being advised that it does not work. UNLESS of course you can get a commercial reason - and not main tax benefit - for the share reorganisation. 'mano786' repliedThanks for the comments. Client hasn't yet gone through the "ill-conceived plan" - if you read the first comments! -------------------------------------------------------------------------------- To view this discussion online (including any possible updates), go to:
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