Phoenixed companies defeated by TAAR
Pete Miller explains how a new tax avoidance rule will be difficult to deal with in practice.
A company is said to have been ‘phoenixed’ when a business owner winds up his company and continues the same business in another company, or in some other format.
Normally, a distribution made in the winding-up of a company is treated as capital. The former company owner will pay CGT at 10% or 20% on the profits of the company, instead of taking dividends which would be chargeable to income tax at 7.5%, 32.5% or 38.1%. If this procedure is repeated time and again the individual will save considerable amounts of tax.
HMRC want to put a stop to such tax avoidance, so have introduced two identical targeted anti-avoidance rules (TAARs) in Finance Bill 2016, clause 35, which relate to certain distributions made in the winding-up of UK or non-UK companies. The new TAARs would take effect for distributions made on and after 6 April 2016, if four conditions are met. Where the TAAR applies the distribution will be treated as income rather than capital.
The TAARs are clearly aimed at the practice of phoenixing a company, but the practical application won’t be straight forward.
The main condition for the TAAR to apply relates to the continuation of the business activity. It requires that, within two years of the date on which a distribution in winding-up is made to an individual who is a shareholder in the company, that individual carries on, either as a sole trader, a partner, or through a company, “a trade or activity which is the same as, or similar to” the activities of the company or of any of its 51% subsidiaries. While there is a lot of information available on the meaning of “the same trade”, there is very little on what is meant by a “similar trade”.
For example, if I liquidate my tax advisory company, but choose to keep on two or three clients in my retirement, am I carrying on a similar trade? What happens if, instead, I start to carry on a business that the company used to carry on a few years ago, although that is not the trade it was carrying on immediately before it was liquidated?
Involved with such a trade
Another TAAR condition refers to the individual being “involved with the carrying on of such a trade or activity by a person connected with the individual”. It is really not clear what is intended by the phrase “involved with the carrying on”.
It can’t mean a proprietorial interest, as the other conditions have already dealt with that. Surely it can’t be the intention that, if you were to join your daughter’s business as an employee, and her business was similar to the one that you have recently liquidated, that you would be caught by the TAAR?
Intention to avoid tax
All of these points are partially resolved by the other TAAR condition; an intention to avoid income tax. In many cases, such as in my examples above, there would be no intention to avoid income tax, so the TAAR won’t bite. However, the winding-up will often, of itself, be a tax saving measure, as it the shareholder will usually pay less tax on a capital gain than on a dividend paid by the company before it is wound-up.
The draft legislation does not clearly link the two conditions together. So it is not obvious that the TAAR is only meant to operate where there is a main purpose of avoiding income tax AND the arrangements include the continuation of the business activity.
The ICAEW Tax Faculty has suggested that the legislation should be changed to make this it clear that there is a link between the two conditions. The CIOT has also condemned the uncertainty the TAAR will introduce into commercial situations.
In the construction industry it is common for a company to be wound up after finishing a particular project, with new projects being carried on in a new company. This is done to ensure that the risk of a new development does not impact on the profits of a previous development. Similar one-project companies are used in other industries.
HMRC have said that they understand the commercial drivers behind this one project/ one company approach to business. However, we don’t know whether HMRC will consider that such a structure as evidence that the main purpose is to avoid income tax (within the TAAR), or whether HMRC will accept that the commercial risk-management over-rides the tax saving motive (outside the TAAR).
HMRC has said it will provide guidance on this area, but there won’t be a formal clearance procedure for taxpayers to obtain a ruling from HMRC on whether the TAAR applies or not.
What advisers should do
Finance Bill 2016, clause 35 determines that distributions made in the winding-up of a company are part of the transactions in securities rules. This means that a prudent insolvency practitioner should probably apply to HMRC for clearance under ITA 2007 s 701 prior to making distributions in a liquidation of any close company.
I suspect HMRC has no idea how many tens of thousands of extra applications under ITA 2007 s 701 they will receive each year, as a result of this ill thought out overlap in the legislation!
If you feel this legislation is badly drafted you can send your views to the Public Bill Committee of the House of Commons at: [email protected] or comment below.
Pete Miller is the senior partner in The Miller Partnership which provides expert tax advice to businesses and other advisers on tricky corporate tax problems and disguised remuneration issues.