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Taxing distributions: A sting in the tail

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7th Apr 2016
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New rules applying from 6 April 2016 look set to bring more complexity to Members’ Voluntary Liquidations - and to business restructuring more widely. Philip and Sarah McNeill delve into the detail in Finance Bill 2016.

Income or capital?

Taxing money extracted from companies as capital, rather than income, has long been advantageous to many taxpayers. Recent changes to dividend taxation from 6 April 2016, and reductions in capital gains tax (CGT) rates, only increase the gradient.

Little wonder that some close companies have amassed high cash holdings and aimed to take out the money as capital through a planned liquidation.

So here we have a potential headache. Abuse of the rules. Road-worthy companies being put into members’ voluntary liquidation, restarted as phoenix companies and profits extracted as capital at the lower CGT rates.

To avoid this, new anti –avoidance legislation follows in pursuit.

Charging to income tax

The transactions in securities rules of Part 12, Income Tax Act 2007 (ITA 2007) have been tightened to counteract the phoenix scenario. Distributions in a winding up have been brought directly within the anti-avoidance rules.

Enter Finance Bill 2016 and Clause 35 introducing a new section 396B into the Income Tax (Trading and Other Income) Act 2005 (ITTPIA 2005). This means that for distributions made on or after 6 April 2016 in a winding up will be charged to income tax if the following conditions are met:

  • Condition A –  the individual has at least a 5% stake in the company
  • Condition B – the company is a close company, or was such within the two years prior to the winding up
  • Condition C - at any time within a two-year period after the distribution:

a) the individual carries on a trade or activity which is the same as, or similar to, that carried on by the company, or a 51% subsidiary of the company

b) the individual is a partner in a partnership which carries on such a trade or activity

c) the individual, or a person connected with him or her, is a participator in a company in which he or she has at least a 5% interest and which at that time –

i) carries on such a trade or activity, or

ii) is connected with a company which carries on such a trade or activity, or

d) the individual is involved with the carrying on of such a trade or activity by a person connected with the individual

  • Condition D – it is reasonable to assume, having regards to all the circumstances, that –

a) the main purpose or one of the main purposes of the winding up is the avoidance or reduction of a charge to income tax, or

b) the winding up forms part of arrangements the main purpose or one of the main purposes of which is the avoidance or reduction of a charge to income tax.

Non-resident companies (s 404A ITTOIA 2005) also fall within the scope.

More complexity

The new rules add further layers of complexity. Take the interaction with disincorporation relief, for instance.  Section 58, Finance Act 2013 disincorporation relief was one attempt to help director shareholders wanting to disincorporate and trade instead via a partnership or as a sole trader.  But the new rules potentially come into play here, as the company business will be carried on by a related party and there could be a challenge that tax was a main purpose of the winding up.

More scope

The Finance Bill also extends the transactions in securities rules within part 13 of ITA 2007 to cover tax advantages obtained by any person, not just the person who is a party to the transaction in securities. The list of securities is extended to include repayments of share capital /premium and distributions in respect of securities in a winding up.

Amounts available for distributions from subsidiaries under the close company’s control are now included. What is meant by a “fundamental change in ownership” is redefined by looking to the change in ownership, voting rights and entitlement to distributions of the “original shareholders” - ie the shareholders before any transaction took place.  The definition of “associate” is also amended.

But no more time

The timescale is definitely speedy. Any transaction or series thereof would have to have been completed by 5 April 2016 to avoid the new rules.  And if HMRC issued a clearance notice before 6 April 2016, but the transaction or transactions covered by the notice take place on or after 6 April 2016, the clearance notice is void if the transaction would be caught by the new rules (clause 33 (9) and (10).

In practice

Going forward, if there is a distribution and the arrangements could look tax-motivated, there are potentially problems going back into business in a similar area.

Replies (15)

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By michael smith
07th Apr 2016 13:09

New Rules and 25K threshold

It would appear that these provisions do not affect an entitlement to take capital treatment if the amount in question is lower than £25K, on the basis that for sums under £25K a formal winding up is not required?  

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By Sheepy306
07th Apr 2016 18:16

Very relevant
@ Michael - is that for definite? It seems a rather significant omission from the article if so.

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Replying to Duggimon:
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By michael smith
07th Apr 2016 19:29

I don't know.  I was more


I don't know.  I was more asking rather than stating as a fact.    But the legislation refers solely to 'winding up' and thus would appear to leave the door open to the £25K.   I was/am hoping that someone could confirm that my reading of it is correct...

 

 

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By JCresswellTax
08th Apr 2016 09:47

I would say

It refers to closing down companies and taking out capital instead of income.

Therefore, it almost certainly applies to the £25k.

On a different note, i don't like the word 'activity'.

Is this intended to catch, say, a person who closes their management consultancy company and takes up a full time employed role doing the same thing within 2 years?  Surely not!

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Replying to TheresMoreToThisThanArithmetic:
Man of Kent
By Kent accountant
08th Apr 2016 10:34

Don't think so

JCresswellTax wrote:

Is this intended to catch, say, a person who closes their management consultancy company and takes up a full time employed role doing the same thing within 2 years?  Surely not!

Attended webinar this week where it was stated that the legislation is not intended to 'trap' those closing their companies because they were going into full time employment instead.

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Replying to TheresMoreToThisThanArithmetic:
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By michael smith
08th Apr 2016 12:07

@Jcresswell... But the legislation states winding up

In both the title and in every condition of S396  the term used is 'winding up'.   I cannot see any reference to 'dissolution' or to ''closing down companies''. 

The term winding up does I think have statutory meaning and involves a formal liquidation process.   The £25K is brought into effect by paying £10 to Co House and striking off/dissolution - an entirely different process both legal and tax position, from a winding up.    Thus this legislation as written does nothing to prevent the £25K route?   

 

 

 

 

 

 

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By Gary Stevens
08th Apr 2016 11:29

Interesting, some thoughts/questions:

1.) Activity - will the legislation define this to not include employment?

2.) Husband & Wife both running similar companies. Does this mean, they will never be able to treat windup distributions as capital distributions? This seems unfair. Even more unfair if they are not H&W but otherwise connected individuals.

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Replying to Paul Crowley:
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By colinwain
11th Apr 2016 11:05

Not just H&W

Gary Stevens wrote:

Interesting, some thoughts/questions:

2.) Husband & Wife both running similar companies. Does this mean, they will never be able to treat windup distributions as capital distributions? This seems unfair. Even more unfair if they are not H&W but otherwise connected individuals.

 

I believe this is the case, not only with H&W, but also if, say, someone's brother was carrying on a similar trade.

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Replying to paulwakefield1:
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By Gary Stevens
11th Apr 2016 14:19

If this is truly the case, it

At Colin Wain, if this is truly the case, it's shocking.

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Jennifer Adams
By Jennifer Adams
08th Apr 2016 13:26

I would say Michael is right...

'Winding up'/liquidation is an alternative/ different process from striking off and the £25K belongs to the striking off as striking off is only possible for a solvent company.

What the section refers to is winding up/liquidation only and as such does not affect the £25K allowed

For more info re the differences see Liquidation - Get the details right and Striking off a company - Get the details right

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John Stokdyk, AccountingWEB head of insight
By John Stokdyk
08th Apr 2016 16:35

Response from the authors

Just to affirm Jennifer's clarification above, I brought Michael's query to the authors' attention and got back the following response. Thanks to all concerned for your efforts on this point. Here's their reply:

There are a number of ways to end the life of a company. Among these are: Members’ Voluntary Liquidations for solvent companies (the subject of the article); Creditors' Voluntary Liquidation for insolvent companies; and striking off, which normally applies to dormant or redundant companies, as any assets left in the company will be lost. The striking off provisions can be used to get rid of an unwanted company. In this case a £25,000 limit on distributions applies.

Striking off provisions

The £25,000 limit on distributions (s1030A Corporation Tax Act 2010) where a company is being struck off still applies. The company must collect debts, pay liabilities and be struck off within two years of the distribution.

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By michael smith
08th Apr 2016 17:18


Thank you all for clarifying my query and for the interesting discussion. 

Especially in view of the increased income tax on dividend payments, the S1030A exemption will remain a useful procedure for solvent, small companies and contractors whose company/current project has concluded.  

 

 

 

 

 

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By petestar1969
11th Apr 2016 12:13

Ok

So if you satisfy all conditions A-D you are caught by the new rules?

If that's the case just make sure you don't meet one of the conditions. B would be the easiest to avoid, surely?

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By NewACA
11th Apr 2016 16:19

Property Development, Joint Venture, Project Specific Companies

Will this affect Joint Venture property development companies, set up for the sale of one specific development? Surely not? 

Many investors in these companies, only invest capital then get a return on capital when the company is closed on the sale of the specific development. They quite often are not involved in the development themselves, but are just silent investors with a large capital introduction at risk - nothing to suggest otherwise that this should be taxed as income.

These silent investors aren't going to be clobbered with income tax instead of CGT are they?

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By gkcorless
11th Apr 2016 16:35

Take over and participant in new company

I have a client who is considering a take over proposal  by a competitor of his 100% owned company (value is substantially in excess of £25K), and as part of the deal, he will receive significant  shareholding  (greater than 10%)in the new company (again a close company) and  become  a director and  employee of it.  This will be in addition to the sale proceeds of his company.

Will he be caught by the new regulation and not be able to enjoy entrepreneurs relief on the company he is selling?

Any thoughts would be appreciated

keith 

 

By the way; both companies are in the same  line of business.

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