Mark McLaughlin warns about HMRC’s response to tax ‘schemes’ that could affect company sales.
A targeted anti-avoidance rule (TAAR) was introduced (from 6 April 2016) to prevent ‘phoenixism’. In broad terms, this practice involves company owners winding up their ‘old’ companies and extracting profit reserves as capital (instead of income) and repeating the exercise in one or more successive businesses.
The effect of the TAAR applying is that an individual who (for example) would otherwise be liable to capital gains tax (CGT) at 10% if business asset disposal relief (previously known as entrepreneurs’ relief) was available on a capital distribution in respect of their shares in a winding up (or otherwise normally 20% for 2020/21) is liable to income tax at rates of up to 38.1% instead (ITTOIA 2005 s 396B; similar provisions apply for non-UK resident companies in s 404A).
Rising from the Ashes
A distribution is ‘caught’ by the TAAR if four conditions (i.e. A to D in the legislation) are all satisfied, which are paraphrased below:
- A: The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up;
- B: the company is a ‘close company’ (i.e. broadly closely-controlled) when it is wound up, or at any point in the two years ending with the start of the winding up;
- C: the individual 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
- 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 an income tax charge, or that the winding up forms part of such arrangements.
The condition that causes most difficulty in practice is condition C, because it is prohibitive.
In the Spotlight…
In February 2019, HM Revenue and Customs (HMRC) published ‘Spotlight 47’ (tinyurl.com/HMRC-Spotlight47), which warns of tax avoidance schemes designed to get around the above TAAR.
HMRC states that the schemes operate 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)’ so that the TAAR supposedly does not apply.
HMRC’s position is that the schemes do not work. HMRC states that it will investigate attempts to avoid the above income tax charge and could challenge schemes using the TAAR or other anti-avoidance legislation. HMRC also threatens scheme users with substantial penalties.
Selling Your Company?
Spotlight 47 is sparse in detail. However, HMRC seemingly objects to circumstances such as where a company with accumulated cash is sold when it might have been wound up instead, and the shareholder carries on the same or a similar trade or activity within a two-year period.
A number of leading commentators have expressed the view that the TAAR cannot apply to company sales. However, Spotlight 47 indicates that company sale ‘schemes’ will be challenged by HMRC one way or another. Individuals who are selling their company (e.g. in ‘cash-rich’ companies) should bear this in mind and seek professional advice if appropriate.
The above article was first published in Business Tax Insider (July 2019) (www.taxinsider.co.uk).