My question is simple - will you help defeat this pernicious proposal the second time round? You will remember that previously HMRC suggested that in legislating ESC C16, which allows distributable reserves of companies being struck off to be extracted in capital form with HMRC permission, a limit of £4,000 would be imposed and an amount extracted above this level would count as a distribution and thus incur an income tax liability for any higher rate taxpayer. I have shown below the text of the objection I have sent to HMRC today and which will form the substance of protest to MPs, if only they will listen. We defeated the income sharing proposals by mass protest previously
Today's proposal is to increase the limit to £25,000 and to apply it to all distributions after 1 March 2012. Now read on...
ESC C16 Proposals
Although the proposed increase in the C16 limit seems a more reasonable figure to counter 'tax avoidance' it still means that for many small businesses with only modest sums available significant additional costs will be incurred by treating the excess above £25,000 as a mandatory distribution unless the taxpayer incurs the additional expense of a liquidation which is estimated to cost £7,500 in a typical straightforward case.
A Taxpayer who has built up a small company on retirement, where £1,000 was injected as original share capital will now face additional tax costs as a result of this proposal and at a business value of £76,000 will have an additional tax bill of £7,500 and so will begin at this level to be better off by enforced liquidation - always assuming that one can be arranged at the quoted figure.
The justification for this is prevention of avoidance but it does nothing of the kind. Businesses with distributable reserves in excess of £75,000 will simply appoint a liquidator and will suffer the additional cost but still pay CGT on the whole of the distribution. How can this then be regarded as "avoidance" or the proposal act to limit avoidance? It simply adds extra costs to the smallest of businesses and increases the cost for slightly larger businesses who will now benefit from the CGT treatment to a lesser extent because of the liquidation costs.
It is clearly not limiting avoidance as the impact assessment admits that over the next five years: "This measure is expected to have a negligible impact on receipts"!
The only beneficiaries of this misguided proposal are liquidators who must be rubbing their hands with glee over the additional fees that will now flow their way.
If HMRC seriously believe that there may be situations where ESC C16 is being used for avoidance purposes then surely the answer is NOT to burden these small businesses with needless additional costs but to include a Targeted Anti Avoidance Rule so that where a taxpayer uses this method of extraction and the object, or one of the objects is the avoidance of liability to income tax, for example by transferring the business to a new entity, whilst having the old entity struck off so that distributable profits may be extracted in capital rather than income form, then HMRC will have the ability to raise discovery assessments to recoup the tax lost.
Incidentally even in the above example, where C16 is clearly used for avoidance purposes, there is an existing anti-avoidance measure which could be brought to bear - the Transactions in Securities Rules, which were themselves amended in 2010 to focus upon Close Companies and avoidance of this type.
If it is still felt that some reasonable limit be applied to the operation of the proposals this should be set at a much higher figure than £25,000 so that the smallest of businesses do not have to suffer this additional cost burden needlessly. If the additional tax cost in a striking off is added to the CGT rate of entrepreneurs' relief it indicates that a taxpayer rapidly loses the advantage of entrepreneurs' relief and at a gain of only £51,000 will be paying an effective rate of 18%, and at a gain of £75,000 where the additional tax cost equates with the cost of liquidation will be suffering an effective rate of 20%.
Given that the benefit of entrepreneurs' relief is suppose to extend to gains of up to £10,000,000 this action, in depriving the very smallest of these businesses from the benefit of this relief is surely contrary to government policy if it is assumed that the gains are not avoidance motivated. If the gains are avoidance motivated surely the sums involved would be expected to be much, much larger than the trifling sums which will be collected from these smallest of businesses and new or existing anti-avoidance measures would be a more appropriate use of revenue resources, given that under these proposals larger transactions where significant avoidance may well be occurring would simply follow the liquidation route and so avoid tax at a fixed cost of £7,500!
I am starting up a government e-petition as well and will notify everyone when it goes live.
Paul Soper FCCA
Replies (43)
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Will read again tomorrow
Hi Paul, thanks for bringing this up.
Probably a bit too late as I started to glaze over (probably a few too many adjectives as well?). Might be easier to start with the bland version which can be downloaded from:
http://www.hmrc.gov.uk/tiin/tiin-esc-c16.htm
Will return, refreshed after a night's rest, but, to start off the number crunching, would be a help to know how you calculated the £7,500 additional tax payable on a £76K distribution? Hoping the other figures you quote will then follow more easily.
Thanks for monitoring the situation
We’re still wading through the mountain of Finance Bill clauses and related documents and it was only around the time you posted this comment yesterday that I spotted tax information notice on the HMRC site announcing that the amount that can be distributed under the concession will be increased from £4,000 to £25,000 at the beginning of March.
This wasn’t what we were expecting, as the perception had taken root that HMRC was looking to repeal the measure as part of its wider review of Extra Statutory Concessions. But the latest information note view that came through the consultation process was that the £4,000 limit below which HMRC would not seek to recover tax on distributions under ESC C16 “was too low to be of value to business”.
The other thing about the C16 measure is that it will no longer be extra statutory. Chapter 3 of Part 23 of the Corporation Taxes Act 2010 will be amended to ignore payouts prior to a company’s dissolution as distributions subject to Corporation Tax, provided they stay below the £25,000 limit. Section 122(5) of TCGA 1992 will also change make this type of distribution a capital distribution - which will qualify for CGT on the gains realised rather than income tax.
So HMRC is making it easier (and cheaper) for entrepreneurs and investors to get money out of their companies. But Paul was already warning us last week that raising the amount people take out of a company under lower tax rates could open the door to avoidance scams and abuses.
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Just read the proposal and its slightly better than before but quite frankly it reads as "we cant be bothered to catch people on the fiddle, therefore we will put this rule in to stop it, and hope the liquidators do our job for them"
NB the £7,500 is the gov estimation of a liquidation. I have had one done for £4k which invovled minimal debtors/creditors although it was a genuine liquidation.
Quite frankly in the instance of a liquidation with just cash in the company and no creditors or debtors there ought not be much cost, but given the very limited number of liquidators I imagine they will be able to charge what they like.
NB if you are going to make a representation to MPs you need to:
1. Keep it brief
2. Take out ALL the emotion
3. Show all your workings carefully.
I think the key here is to show that small business lose out, but big business dont care, ie its the little guy getting hammered. A simple table showing reserves and tax cost would be easy to run up at £25k intervals from nil to £100k and then say £250k, £500k £1m etc.
The basic argument is unfairness - one rule for the rich, one for the poor which MP's might understand.
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Additional point - one additional option other than a much higher limit at which point there the cost of a formal liquidation is the same as the tax saved is to allow accountants to handle liquidations in instances where there are no known creditors or debtors other than the directors. This would being the cost down from £7,500 to a few hundred pounds. Its really not hard to call a meeting that no-one shows up to, minute it and file a few documents with companies house.
That is to say you need to have concrete alternative proposals other than "this is bad", you need to say "do this instead".
NB if you note HMRC seem to think this wont raise any revenue, if this is the case then you can propose than adjusting the thresholds up wont make any difference either....
John, how is this better?
John, the £4k limit you refer to was never invoked - it was only a suggestion at the consultation stage.
At the moment, the capital treatment is unlimited, so this new law is a dramatic reduction and detrimental compare with what we have today.
So HMRC aren't making it cheaper and easier - it's going to be more expensive for anyone with a balance of over £25,000 than it is today.
The only good thing is that it's only better than their initial suggestion in the original consultation document.
@ken & @paulsoper
My understanding was that the £4,000 limit was an unofficial threshold below which the Treasury Solicitor felt it wasn't worth pursuing "illegal" distributions by struck off companies, but that they retained the right to seek income tax on larger amounts.
I've been following the lead of more informed members and have only been reading up about this since it flared up on Aweb in the past month or so. If I have misconstrued the existing ESC, please forgive me. Unfortunately we're having to move very quickly to summarise a Budget's worth of new legislation.
Your advice (and protests) are a very welcome way to balance the debate, and we'll be following up shortly with a more definitive technical summary.
@John Stokdyk
The £4000 Treasury Solicitor limit is a different thing. It relates to Bona Vacanta rules where the Crown (or the Duke of Cornwall / Lancaster if you live in those areas) takes the entire reserves of the company.
Hold on a mo
John - Unfortunately many got the Bona Vacantia & ESC C16 issues confused or conflated. They are effectively two different things but are both seeking to make life easier (or more difficult depending on your side of the fence) for small Ltd companies wishing to be struck off.
Paul S (and maybe others) under the new rules, if you exceed £25K, it's the entire distribution that is treated as a dividend not just the excess over £25K so you might need to re-do your sums?
By the way the responses to the consultation on this are below. 42 responses, including the reg bodies, difficult to see how an e-petition will be taken seriously if only 42 organisations could be bothered to respond when asked? missed & boat come to mind.
still a little conflation/confusion
Paul S (and maybe others) under the new rules, if you exceed £25K, it's the entire distribution that is treated as a dividend not just the excess over £25K so you might need to re-do your sums?
I am not sure this is the case. Under the new proposals you can still use ESC C16 to treat the first £25,000 as a capital distribution.
For example if you had £100K to dstribute, you could make an initial distribution of £25K which would be treated as capital, and the remaining £75K would be treated as income.
Obviously, if you go down the winding-up route with a liquidator, the entire distribution (£100K) would be treated as capital.
Bona Vacantia & ESC C16 confusion
"Unfortunately many got the Bona Vacantia & ESC C16 issues confused or conflated. " Indeed! Look at the article about ESC C16 on page 32 of this month's Accountancy, which starts with the sentence - "In a surprise move, the Treasury Solicitor has withdrawn ESC C16". Unbelievable!!
Am I right in the following scenario - Company with Share Capital £100k and P&L 20k. After 1.3.12 (when the enactment of ESC C16 has come in), the Company can wind itself up using DS01 and simply pay £120k to the shareholders as capital. The Treasury Solicitor won't chase the Share Capital (following their recent announcement on Bona Vacantia) and HMRC won't seek to say that the £20k reserves are income, as they are below £25k?
I am shocked by these proposals but not surprised
I will of course be supporting any petitions against this proposal.
Initially, your liquidator is going to have a field day, but I can see the growth of lower cost operations to take advantage of these rules.
However, I am hoping that HM Goverment will see sense on this ocassion.
This measure is targeting genuine hard-working businesses who have paid all their taxes down the years and have built up reserves towards their retirement etc.
But of course, these people are an easy target.
I don't see any proposals to tackle your serial fraudster, who sets up businesses and evades tax as a career.
Liquidation and stuff
I've been puzzling over how the previous estimate a couple of years ago of up to £4K could become £7.5K? The upshot of this of course is that such a figure starts a bandwagon of complaint over unfairness.
The problem with trying to estimate this cost is that, at the moment, a typical job for an IP involved in liquidating a small business, with a bank account, a few debtors/creditors, maybe a lease and a small tax bill could well average £7.5K and so this would be the figure they'd quote if called up by HMRC for an estimate.
My typical strike off however is nothing like this, they will have stopped trading a few months back, all the creditors & debtors cleared and HMRC happy leaving a bank account or, more often, a director's loan where all the funds had already been drawn in anticipation.
This sort of case has not been handed to an IP for decades however if they now start getting them their fees will be less, plus, with so many new cases about, the laws of economics and competition will dictate that the costs will come down. I've just got of the phone to an IP who said £2.5K to £3K.
We should not forget that the current unofficial regime has been a bonus. Clients have been lucky that it's been around for so long and so I really can't get heated up by the government's need to tidy it up. As I pointed out, on another thread, there has been huge tax avoidance by companies building up mega funds that might well have been regarded as investment operations rather than trading concerns and so this provision brings some reality to their situation and the cost of an IP is just the medicine thay have to take.
My main complaint is that companies will still be struck off with no submissions and no policing by HMRC or Companies House, this provision is for the honest (or semi-honest) ones only and so a far more joined up approach is needed.
Tony
Interesting point over the first £25K. My reading of the document (top of 2nd page) was that the total distribution (if >£25K) would be treated as a dividend. I also confirmed this direct with HMRC.
Likely I've missed something here, how would I engineer one cheque for £25K today as capital and another tomorrow for £50K as a dividend?
Pay a dividend first
My take is that you vote a dividend first, to pay out all reserves except the remaining £25,000 then pay out the remainder of £25,000 as the capital payment.
IP costs - opportunity for accountants?
I've just signed the e-petition so I've done my bit. The last one I signed was Joanna Lumley's for the gurkhas so hopefully this will succeed also. Sadly, I don't think this one will capture the public mood quite as much though.
I had an IP visit my office a few weeks ago to discuss possible referrals and we discussed the C16 affair. I told him we could probably put some business his way IF their fees were reasonable. He sort of said they would be, although figures were not discussed.
No doubt fees will come down eventually, but only if the market opens up to new entrants. Accountants are ideally placed to take advantage of this, but it depends on the barriers. For example, would you need to pass special exams or take out expensive insurance to do this sort of work?
Maybe the institutes should work with the PI insurers to create an opportunity for us to service what is bound to be a lucrative new market. For example, they could create a separate class of IP work (call it IP-lite or ex DS01 work) which would only be available to non-IPs if a) they are qualified accountants or tax advisors, and b) the company to be liquidated has no external creditors other than pending tax bills, no assets to value, no meetings to be presided over and maybe one or two other things.
As for HMRC trying to plug a tax loophole, they should use the powers already available to them first before making life difficult for the small business community yet again. Previous posters have already said how this could be done so I won't repeat it all again.
However, an easy solution in this age of instant information would be for them to check directors of newly formed companies against their own database for companies granted ESC C16. That would instantly identify the cheats breaking their assurances by setting up phoenix companies. Or is that too simple? Perhaps any HMRC bods reading this could put it through their staff suggestion scheme and see what happens!
Chris
Still confusion
Thanks for clarification of the split of div (1st) & capital distributions (2nd) which is, of course, is how it should work.
From people I've spoken to however there is enough confusion around to produce a trap. Say for example the company has £30K to pay out, nobody would consider approaching an IP and there are those who think that £25K will be treated automatically as Capital and so they pay out £30K declaring £25K as Capital and £5K as dividend, whereas of course, without the paperwork in place and maybe two cheques, the whole £30K is dividend.
Chris "IP-lite"- I think you raised this point on a previous thread. I can certainly see the sense of allowing me to do a liquidation-lite on my own clients as I know their history but there is still a risk that the client did something in the past that could come back and bite the liquidator (lite or not) on the [***]. I could take out insurance or similar to protect myself but then I'm becoming heavy and costs rise. The alternative is to insist on an indemnity from my client but I'd have to be able to keep track of them for years. Obviously all this risk is multiplied greatly if the company was not my client.
I have discussed this with IPs and they rightly say, you can have the neatest members' vol presented to you with little leg work to do but unless you spend the time investigating and triple checking the history and documenting it (which is what takes the time) it's only a matter of time until you catch a cold. Which is why the 86 Act came into being.
I used to carry out liquidations pre 86 and still remember crossing my fingers, so was only too happy when the law put it out of my reach. Horse for courses.
Paul that's still a distribution
Any amount paid in excess of the amount originally subscribed for shares is still an income distribution. Capitalising reserves doesn't alter the amount "subscribed" for the shares.
EDIT: That's not actually quite the way the legislation is worded (S.1000 CTA 2010), but it has that effect. You need to liquidate to get it all as capital.
The bill has yet to be debated in Parliament, so small business clients might also be encouraged to write to their MPs on the matter.
The plot thickens
Interesting exchange above about the merits or otherwise of recognising share capital & P&L.
Again, I may have got this wrong but, nowhere in new ESC C16 have I seen reference to determining share capital & reserves when talking about distributions, ie if we are trying to avoid a formal winding up then a distribution is a distribution, and the only capital element would be if you could engineer it that the last cheque you write is less than £25K. That's the capital bit regardless of whether the share capital was £100 or £100K.
So in Colin's unusual example (share cap £100K & share cap £20K) I feel you have a problem to use any of the £25K. The maximum cheque you can write as a dividend is £20K then you have £100K to distribute, I hardly think you can write one for £25K and another for £75K, the whole £100K is a distribution on strike off and so is all taxable as a dividend.
So, I suppose what you do is reduce the company's share capital to £1 returning a £99,999 capital sum, under normal company law, to the shareholder then pay £20,001 on strike off as a capital sum?
Any views?
I wonder if it would be possible to make a freedom of information request to find out how many companies have used ESC C16 and the value of distributions. It would be good to find out how many companies have used the concession at varying amounts. I'd guess it is used mostly in the £25k to £100k range, simply because larger amounts would tend to be done by a liquidator anyway given the likelihood of greater complexity, and at the lower end, small distributions would be done as dividends for smaller businesses as there'd be no need to go down the capital ESC route if the recipient wasn't liable to HR tax on the income distribution. I wonder if they've used an arbitrary level of £25k in full knowledge that not many people would use it - to me it's not much better than their first idea of £4k.
Ken
Your FOI request might gather the number of ESC C16 applications but, as there is no direct disclosure of the value of distributions connected with each ESC C16 application, I don't think you'd get the info you want.
I'd also make the point that many ESC C16 applications are made, even if distributions are negligible or even £0, in order to protect the company from an objection from HMRC as and when the strike off application is made public.
As discovered last year, I think, with thousands of strike off applications a month HMRC appear to be unable to monitor this and so the real loss of revenue to my mind is in companies taking advantage of this by making distributions, not employing ESC C16 and striking off.
Again therefore kicking up a fuss about a change in regs that merely lessen the effect of a tax "get out" and that may only apply to the minority of strike offs seems a waste of time. Surely, if there is a petition, it should be to tighten up the law on the unregulated strike offs, enabling the correct tax collection. You never know, if this happened you might even get a relaxation from £25K to £26K?
Balderdash!
"the change is to make life easier for HMRC who can pass the buck to taxpayers under self assessment."
Like many other ESCs, the granting of C16 is beyond HMRC's powers, following the House of Lord's decision in Wilkinson (in 2005?). As a lecturer involved with a lot of ACCA seminars, you'd know that. The easy thing for HMRC to do, following the Wilkinson decision, would be to stop granting ESC C16 ultra juris.
It's better to have the relief on a statutory footing, than to not have it at all. That way at least there's scope for getting the limit increased.
certainly true
It's better to have the relief on a statutory footing, than to not have it at all. That way at least there's scope for getting the limit increased.
However, a more sensible amount eligible for capital treatment would be £100,000 rather than the £25,000 proposed.
Additionally, companies with all their affairs in order, paid all their debts etc, will be in a position where they will need to appoint a liquidator (to take advantage of entrepreneurs relief etc).
Good news for your liquidation consultant.
Another point: my understanding was that HM Government was consulting on ways to make it easier to disincorporate. Surely this is a backwards step.
Repayment of share capital
To Paul Scholes - I agree with Paul Soper on the distribution point. A repayment of share capital, even under ESC C16, is not a distribution. How can the repayment of a non-distributable reserve be a distribution?!
CCAB
Am I missing something but surely this is a matter for urgent joint representation by the CCAB bodies to Govt/HMRC on the basis that this proposal is clearly at odds with "rewarding" small business owners who have a "can do" approach and who then contribute significant funds to the economy over many years via all the other taxes that are paid by them and then will most likely reinvest their hard-earned pay-offs into other tax-generating areas by providing income streams to businesses who then pay taxes etc. The limit should be at least £100k - £25k is a nonsense. Do the CCAB have a "can do" mentality?
Economy with the truth or a waste of time ...OR ...
HMRC's Press Release claims that the effect of the measure will have a "negligible impact on [tax] receipts".
If this is the case then why does ESC16 need changing along the proposed lines? What a waste of Parliamentary time!
OR just maybe there's a hidden agenda - to drum up business for professional liquidation firms - as distributions via this costly route will not be subject to the proposed £25,000 limit.
OR maybe there's an undercurrent of evil within the Civil Service that likes to impose more costs or burdens on small businssses? This undercurrent is presumably out of control, otherwise nonesense like this would have been nipped in the bud months ago.
review of ESCs
If this is the case then why does ESC16 need changing along the proposed lines? What a waste of Parliamentary time!
As pointed out by George above, HMRC are reviewing all ESCs - refer to Wilkinson case 2005.
ESC 16
The real point being the rip off fees liquidators charge for straight forward work !
Only 28?
So far, only 28 signatures and precious little sign of any "movement" on this or other fora to challenge the proposal. I really can't believe how little interest there has been. This will affect thousands of the smallest businesses and yet the accountancy profession doesn't seem to care. Perhaps those occasional posters who come on these fora and acuse the accountancy profession of lack of action were right after all! Don't we care about our clients at all, or are we just wanting to use them as cash cows?
Still not convinced
Firstly, Paul S some interesting points above, I did not know of the Gaines Cooper case.
Secondly, Paul (and Colin), in your posting "What is a distribution" above you set out the case for a reduction in share capital but I think you missed the fact that I had already suggested that in my posting 3 hours earlier (last para). I agree, the answer to Colin's unusual situation would be a reduction in share capital under normal company law rules to put the company into a better state for a strike off under ESC C16.
Once such dust has settled however and all activity in the company has ceased you have a bank account with £X in it and I still say that, for the purposes of ESC C16, when a cheque goes to a shareholder it is a "distribution", ESC C16 is blind to capital & revenue, it has to be because it ignores the strict letter of the law that does not permit the return of share capital on a winding up without a formal liquidation.
This is an academic issue because, in reality the majority of strike offs take place with minimal share capital to worry about and an accumulated pot of retained reserves that the owners want out. We can also discuss till we are blue in the face our own "average" pots and whether £25K is fair to small businesses (whatever they might be). By the way, it's not the business that's advantaged or disadvantaged it's the person(s) and their private wealth, the business no longer exists (or shouldn't do)
In my experience of strike offs (£300K to £1K) (and with confidence that liquidations will cost nothing like the £7.5K quoted), I can only see a narrow band of people who this change will disadvantage and only then if they are already into higher rate tax, so hardly the poorest of the world. We should also not forget that a significant number of small businesses will not have had the luxury of being able to build up £25K let alone £75K.
(Paul, Ken and others), as I said before, if you are so heated up by this issue why leave it till now (a year after the 4th consultation) to let off steam? There are far more pressing inequalities in our society that I would rather spend my time on, so count me out of this one.
A benefit of the enactment of ESC C16
While on the subject, I can see a benefit of the enactment of ESC C16. Under the concession as is, the directors/shareholders have to send a letter to HMRC, which, among other things, gives assurances that they will "supply such information as is necessary to determine, and will pay, any Corporation Tax liability on income or capital gains ". After the enactment, I assume that the directors/shareholders will not have to send to HMRC such a letter, as they will not have to get clearance from HMRC. I had a case in the last year where, long after the ESC C16 application and subsequent striking off of a company, HMRC asked for info relating to the deceased company. I told them to "go away" as the company no longer existed. They then withdrew the ESC C16 approval, on the basis that the director had not fulfilled his part of the ESC C16 bargain by "supplying such information ......", and raised a rather large assessment on the client, with the capital receipt changed to an income receipt. They said that they would reverse this assessment if the information that they wanted on the deceased company was given to them. Hopefully after 1 March 2012 such "blackmail" tactics by HMRC will no longer be possible, if there is no 2 way ESC C16 "bargain".
Withdrawal of ESC C16
I had sympathy for my client! I and everyone else I have spoken to about this, other than HMRC, was always under the assumption that the assurances covered the giving of information relating to the known tax liabilities at the date of striking off, and, if HMRC missed the boat by not objecting to the striking off, then they were too late and they couldn't later try and ask for information in order that they could try and make a posthumous discovery. If they, through other sources, made a discovery then fair enough, but they hadn't, they were only fishing.