By Clare Munro, Tax Partner
It seems that HMRC have been busy over the past few weeks. Tax announcements are coming thick and fast, but one of the recent HMRC announcements could result in you having to pay more tax on your company's cash than you might have expected to.
Most company proprietors will know that, if they dispose of their shares, the profit they make on their original investment is subject to capital gains tax (CGT) rather than income tax. For disposals of trading companies, the availability of Entrepreneurs' Relief can take the CGT rate down to 10%, a result some 20% lower than the current top tax rate on dividend income. That gap will increase from April 2016 and HMRC are concerned that this will present an even greater incentive to liquidate companies to exploit the difference by realising a capital gain.
Just before Christmas, HMRC published draft legislation accompanied by a consultative document setting out their proposals for limiting the opportunities for shareholders to realise a capital gain by winding up their company. The consultation sets out what HMRC regard as 'abuse' and, in particular, gives examples of:
- 'Moneyboxing' - where a trading company builds up reserves and cash within the company rather than paying out dividends and is liquidated in order to give the shareholders access to those reserves as a capital gain.
- 'Phoenixing' - where a company trades for a short time, is liquidated, and the proprietor starts up a similar business personally or in a new company.
The tax legislation has always included anti-avoidance rules to prevent taxpayers from transforming what, in the Revenue's view, should be income, into a capital gain in order to avoid tax. Liquidations have been a grey area, in that HMRC could have used the anti-avoidance rules to attack a tax-motivated liquidation but have not historically done so and, in fact, their guidance indicates that they regard a normal liquidation as outside these rules.
The draft legislation aims to tighten up these anti-avoidance rules. Specifically, from 6 April share buybacks and distributions in liquidation will, by statute, be classified as transactions in securities putting beyond doubt that they can be challenged by HMRC (there is still no requirement to ‘self-assess’ these provisions for ‘artificial transactions in securities’).
In addition, a new ‘targeted anti-avoidance rule’ will apply to treat distributions on a liquidation or winding up as income if certain conditions are met, one of which is that the person receiving the liquidation distribution (or a company which he owns) is carrying on a trade which is the same as or similar to that undertaken by the wound up company. Unsurprisingly ‘similar’ is not defined which could cause difficulty with interpretation.
Overall we can expect these changes to make it easier for HMRC to challenge liquidations, although it remains to be seen how HMRC interpret the amended rules. The tighter rules will cause problems for anyone whose business approach involves serially incorporating and winding up companies (property developers, for example, tend to do this in order to insulate each development commercially), but the position of companies which simply fail to distribute their surplus cash is not yet clear.
On the one hand the HMRC use of a ‘moneybox’ company as an example of abuse indicates that, armed with a statutory definition of transaction in securities which includes liquidations, they expect after 6 April to be able to challenge the liquidation of any moneybox company with or without a phoenix. On the other hand, the guidance indicating that they still regard a normal liquidation as outside the anti-avoidance rules is still in place for now at least. One might have expected them to withdraw it if that view had changed and the consultation discussion of further legislation to prevent abuse (for example by a system of 'notional dividends' of undistributed reserves) suggests that, for now, a ‘normal’ exit by an outgoing shareholder should be unaffected.
Whilst this announcement should not be a cause for panic, the widening gap between taxation of dividends and capital distributions is clearly on the government’s agenda, and the climate for creating capital gains events after 6 April is inevitably going to be more hostile than it is now. So, if your company is cash rich and you plan to extract the funds only on liquidation, it may be worth considering whether it is practically possible to do anything about that now. Of course, with the increased tax rates on dividend income from April 2016 (after the £5K dividend allowance) trading through a company will be less attractive for some, and this uncertainty can only reduce the benefits of a company structure.
Please do get in touch with me if you’d like to discuss how these issues could affect you, or speak to your usual contact partner.