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Mark McLaughlin CTA (Fellow) ATT TEP highlights a future change in approach when winding up owner-managed business, and some related tax issues.

Mark McLaughlin

Forthcoming changes

Winding up owner-managed companies was the subject of ‘Points of Practice’ in Busy Practitioner a year ago (Issue 52, December 2006). A popular approach to ending such companies has generally been to apply Concession C16, subject to approval by HM Revenue & Customs (HMRC). This is despite the fact that, under the Companies Act, it is unlawful to return capital to shareholders other than on a winding up (see ‘Come in C16, your time is up’ by Philip Ridgway in Tax Adviser, August 2007).

However, this legal dilemma is shortly to be resolved following changes to be introduced in Companies Act 2006. A private company will be able to reduce its share capital by special resolution, supported by a solvency statement (CA 2006, s 641). This will allow a company to reduce its capital in any way it chooses, including repaying share capital in excess of the company’s ‘wants’. However, there are certain conditions attached to the capital reduction procedure. There must be at least one member holding a non-redeemable share following the reduction. In addition, the procedure is subject to anything in the company’s articles preventing a reduction of the company’s share capital.

As mentioned, the company’s directors must make a solvency statement up to 15 days before the passing of the special resolution (CA 2006, s 642). A copy of the solvency statement and a statement of capital must be delivered to Companies House within 15 days of the resolution to reduce the company’s share capital being passed. A copy of the resolution must also be filed (s 644).

The solvency statement must state that, in the opinion of the directors:

• the company is able to meet its debts; and
• if the winding-up is to commence within twelve months of the solvency statement, the company will be able to fully meet its debts within that period (or otherwise the company will be able to meet debts as they fall due during the year immediately following the solvency statement).

A solvency statement should not be taken lightly. The directors must have reasonable grounds for the opinions expressed in a solvency statement delivered to Companies House, or otherwise a criminal offence is committed. The maximum penalty in the case of conviction on indictment is two years’ imprisonment, or a fine, or both. Upon summary conviction in England and Wales, the maximum penalty is twelve months’ imprisonment (six months in Scotland and Northern Ireland), or a fine up to the statutory maximum, or both (CA 2006, s 643).

The company and its officers are also liable to a fine if the company files a solvency statement with Companies House that was not provided to the shareholders by the time that the proposed special resolution was submitted to them, or at a general meeting to propose the special resolution (CA 2006, s 644).    

Tax treatment

At present, capital distributions by companies to shareholders during a winding up, whether under Concession C16 or in a formal liquidation, are not treated as income payments, but as full or part disposals for the purposes of capital gains tax or corporation tax on chargeable gains.

The same tax treatment will apply to capital repayments under the Companies Act 2006 rules. A ‘capital distribution’ for capital gains purposes includes a distribution in money or money’s worth during the course of dissolving or winding up a company, unless the distribution constitutes income in the shareholder’s hands (TCGA 1992, s 122(1), (5)).

Commencement of new procedures

Unfortunately, the Government announced on 7 November 2007 that the commencement date for certain Companies Act 2006 provisions originally due to commence on 1 October 2008 was being put back to 1 October 2009. This includes the share capital reduction provisions in CA 2006, s 641. Whilst the Concession C16 procedure will eventually become a thing of the past, it is therefore going to be around for some time yet, and for a little longer than originally expected.

Transactions in securities

Capital distribution treatment upon a winding up, whether under the existing Concession C16 procedure or under the forthcoming share capital reduction provisions in Companies Act 2006, is subject to anti-avoidance legislation aimed at the cancellation of a ‘tax advantage’ obtained through transactions in securities (ITA 2007, s 684, previously ICTA 1988, s 703). Capital receipts caught by this legislation are subject to income tax instead. An application to HMRC for an informal winding up under Concession C16 does not cover transactions in securities.

HMRC officers are instructed to consider whether those provisions potentially apply to distributions during a winding up of the company, and are invited to report “…cases under sub-paragraphs (e) or (f) of CTM 36875” to their Anti-Avoidance Group (CTM 36220). Those sub-paragraphs no longer exist. However, CTM 36875 lists a number of situations potentially caught by the transactions in securities provisions. Whilst none of those situations deal directly with distributions in a winding up under Concession C16 or upon a reduction in share capital, HMRC state that the anti-avoidance rules do not apply to an “ordinary liquidation” (CTM 36850). This is defined as the winding up of a company following the complete cessation of its business or to the transfer of that business to an unconnected person.

‘Phoenix’ companies

At the time of writing (November 2007), following the Government’s proposals to increase the capital gains tax rate to 18 per cent and to withdraw taper relief and indexation allowance from 6 April 2008, many company owners are looking for possible ways to effectively ‘bank’ their accrued entitlement to business asset taper relief (and possibly indexation allowance, up to April 1998) by triggering a disposal of their shares.

However, winding up the company and re-commencing the same business in a new company under the same ownership may not be a valid way for the business owner to successfully achieve this objective. If a business is transferred to substantially the same owners as before, HMRC are likely to challenge the winding up as involving a transaction in securities, unless the business is transferred as part of a genuine company reconstruction within TCGA 1992, ss 136 and 139, and by applying Insolvency Act 1986, s 110.

The anti-avoidance provisions regarding transactions in securities are fairly widely drawn in respect of a ‘relevant company’ (i.e. broadly including a close company). The rules can apply to the receipt by a shareholder of consideration in the form of a transfer of assets available for distribution (ITA 2007, s 689, derived from ‘circumstance D’ in ICTA 1988, s 704).

The rules can also apply to consideration relating to a transfer of distributable assets from one close company to another, where the consideration is the issue of share capital or loan notes (ITA 2007, s 690, derived from ‘circumstance E’ in ICTA 1988, s 704). This can catch a company reorganisation involving the transfer of Company A’s trade and assets to Company B, which results in the distributable reserves of Company A being represented by capital in Company B. In the case of non-redeemable share capital, the anti-avoidance rules apply as and when the share capital of Company B is repaid, and ‘repaid’ in this context includes distributions in a winding up or dissolution of the company.

Advance clearance

For cases in which ITA 2007, s 684 could apply, an application for clearance in advance under ITA 2007, s 701 should be made to HMRC’s Business Tax Clearance Team. If the taxpayer can show that the winding up is being conducted for bona fide commercial reasons and that obtaining a tax advantage was not a main purpose, section 684 will not be invoked, provided that full disclosure has been made in the clearance application.  

Bona Vacantia (England & Wales)

When a company is dissolved, any remaining assets strictly pass to the Crown (CA 2005, s 654). This rule (‘bona vacantia’) is continued in the new Companies Act 2006 (s 1012). Presently, if the shareholders have taken advantage of Concession C16 and the company has been struck off under sections 652 or 652A, the Treasury Solicitor’s Office will waive the right to recover an unauthorised distribution of share capital amounting to less than £4,000. This concessional treatment is confirmed in form BVC17 (‘Guidelines about the distribution of a Company's Share Capital’), which can be accessed on the Treasury Solicitor’s bona vacantia website: (http://www.bonavacantia.gov.uk/default.asp?pageid=1409).