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Tax avoidance: Blocking the CGT route

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10th Dec 2015
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Blocking tax avoidance routes is a game of whack-a-mole; the Government hits one down and another one pops up.

The draft Finance Bill 2016 contains at least a dozen anti-avoidance provisions, and one of those is targeted directly at owners of small companies.

The new dividends tax is going to make it less attractive to extract profits from a company in the form of dividends – but not entirely unattractive as Giles Mooney pointed out. However, the dividend tax set at 7.5%, 32.5% and 38.1%, may encourage people to keep funds within their company, then later extract value as a capital gain that attracts CGT at 18%, 28%, or even 10% when entrepreneurs’ relief applies.

There are four broad ways of turning the income trapped within the company, into a capital gain in the hands of the shareholders:

  • Sale of the shares to a third party;
  • Purchase of shares by the company;
  • Repayment of share capital; and
  • Liquidation or winding-up.  

The Government is consulting changes to the tax treatment of company distributions to prevent people from flagrantly changing income into lower-taxed capital. Changes will be introduced from 6 April 2016 in FA 2016, but that may not be the end of the upheaval in that area as the consultation document suggests.

Sale of shares  

Where the sale is made to third party, and is not “contrived”, the sale will be taxed as a capital gain.

However, the transactions in securities rules (ITA 2007, part 13) will be tweaked to ensure that where the transaction is between connected parties (including trusts), the proceeds may be taxed as income not gains.

Purchase of own shares

The rules for obtaining capital treatment of the proceeds when an unquoted company buys back its own share are already fairly tight.

The shares must have been held for five years, the transaction must be for the benefit of the trade, and the shareholder must reduce their holding so they hold no more than 30% of the company (which includes the holdings of associates).

In spite of all these conditions the Government believes the rules could be exploited to generate a capital gain. The revised transactions in securities rules could be used to ensure that where the shareholder has a tax advantage (receiving capital rather than income), the transaction will be taxed as income.

Repayment of share capital

If a company repays part of its share capital to its shareholders, that is not regarded as a distribution, and there is no income tax charge.

However, where the structure of the company is changed so that retained profits are turned into share capital of a holding company, then the holding company repays that new share capital to its shareholder, that is  “unfair”, as the shareholder will be taxed on a capital gain not income.

Once again the revised transactions in securities rules will prevent this.

Liquidation

Where a company is formally liquidated the proceeds received by the shareholders are treated as capital, but there is always a fee to be paid to the liquidator. The consultation document says a members’ voluntary liquidation (MVL) can be performed for as little as £1000, which I doubt.

The Government is concerned that business owners will be encouraged to repeatedly form and liquidated a series of companies, essentially phoenixing the same business through different companies.

This behaviour is already prevented by the transaction in  securities rules, but just to add belt to braces the Government will introduce a new targeted anti-avoidance rule (TAAR) to prevent this type of transaction.

The danger is that these new rules will catch genuine winding-up of companies at the end of their business lives, where there is a significant amount of cash held within the company.  

The consultation will run until 3 February 2016, so if you have time over Christmas you can send your response to [email protected] or add your views below.

Rebecca Cave will shortly be producing a report for our sponsor Keytime on what the new Autumn Statement and Finance Bill 2016 measures will mean for small businesses.

Replies (4)

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By Peter The Painter
10th Dec 2015 10:58

Fragrantly ?

Does it pass the smell test?

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By Ruddles
10th Dec 2015 11:40

Mountains out of molehills, sledgehammers and walnuts

The logic displayed by HMRC in the condoc is, at best, seriously flawed. In one example, they suggest that it is unfair that a shareholder is able to secure CGT treatment on an MVL where another shareholder would be have to pay income tax on a dividend of the same amount extracted from an ongoing trading company. Perhaps if HMRC were intelligent enough to compare like with like I might have some sympathy for their stance. Did it not occur to them that shareholder 2 would be entitled to the same CGT treatment once their company had also reached the end of its life?

Courts have established over a number of years that there is nothing inherently unfair or abusive in a taxpayer choosing the more tax-efficient of a number of options (so long as it is not contrived or artificial). I find nothing artificial or contrived about passively leaving cash in he company. Just because a distribution might have been taxed as income had the taxpayer taken steps to ensure that was the case, in my mind doing nothing is not an active step of turning capital into income, and I find HMRC's suggestion that this is somehow unfair to be quite absurd. My wife puts £30k into premium bonds and I pay £30k into my pension. Is it unfair that she  doesn't get tax relief on her investment, whereas I do?

The other examples (phoenixism, creation of capital via holding companies etc) I have less an issue with.

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By norstar
07th Jan 2016 10:57

Discriminatory

For what it’s worth, my view is that this measure unfairly prejudices genuine businesses and undermines the purpose of Entrepreneurs relief.

This is an ill thought out measure which appears to be being rushed through without proper time to consult and amend it.

Let's take a genuine entrepreneur who builds up a close company in the cleaning industry, employing 5 people. For tax reasons, draws a minimal salary and dividends are modest. Builds up £100k of reserves over time.

Sells the trade to a third party for £10k with a non-compete clause for 6 months or perhaps takes a year out.

After that starts a new company and goes back into the industry they know best.

Your measure will prevent him from benefitting from ER.

This measure is therefore, in my opinion, discriminatory, grossly unfair and disproportionate and potentially illegal. Who will qualify if you exclude companies because they are "close" or because HMRC think it was done for tax purposes?

If the purpose of this measure is to prevent phoenixing (which is fine), then a timescale of no trading within six months would achieve the same purpose but not prejudice genuine business cases where someone ceases to trade and distributes assets on winding up.

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By jennyTrading
14th Apr 2016 11:53

Does it pass?

Does it pass in April 2016? Or just a draft? Any update on this?

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