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End of the line for ESC C16?

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24th Feb 2011
Editor in Chief (interim) AccountingWEB
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Andy White from CBW explains how Extra Statutory Concession C16 can reduce the tax liability when companies are struck off, and warns that it may become less generous when it moves to a statutory footing.

For many years HMRC has operated a number of “extra-statutory concessions” that set out circumstances in which the department will not collect tax which is legally due.

Concession C16 sounds like it could be a bus route to Nether Wallop, but is actually a popular concession which may also be at risk from government cutbacks. A consultation document published in January set out a raft of planned revisions for ESCs including C16. This explains how the concession currently works, and how it may be affected by the review.
 
When a company comes to the end of its useful life, a liquidation followed by a division of assets amongst the shareholders will be subject to capital gains tax (CGT). With the differential between income tax and capital gains tax rates currently so large, this represents a very tax-efficient way of winding up a company’s affairs. The availability of the annual CGT exemption as well as the possibility of Entrepreneurs Relief reducing the headline rate to 10% add to the attractions.

The alternative method of disposing of the company is to have it struck from the Register of Companies. This is a very cost-effective informal procedure which has become increasingly popular.

Formal liquidations can be expensive and time-consuming, yet a distribution of the proceeds without a formal liquidation cannot be treated as a capital distribution. If the informal “striking-off procedure” is used, then the strict legal position is that any distribution to shareholders would be subject to income tax, as if it were a dividend.   

Enter ESC C16. Providing certain conditions are met, the concession allows a distribution to shareholders ahead of an informal striking off to be treated as a capital receipt subject to CGT. Shareholders can use the concession to extract the assets from a company without a heavy tax penalty and without the costs of a formal winding-up.

One frequently overlooked aspect of ESC C16 has nothing to do with tax, but is a company law issue. Strictly speaking, distributions do not include the repayment of paid-up share capital. Since ESC C16 does not apply for company law purposes but is a tax provision only, it does not allow assets representing share capital to be distributed. Such an action would be unlawful in company law terms.

In the absence of a winding up procedure the company's share capital is strictly “bona vacantia”,  which means it becomes an asset of the Crown, Duchy of Lancaster or the Duke of Cornwall.

In practice the Treasury Solicitor will allow up to £4,000 to be repaid without seeking recovery as an unauthorised distribution. Given that most small companies have a share capital of as little as £2, with the remaining assets representing reserves, this does not usually present a practical problem.

Recent announcements indicate the government’s intention to give legislative effect to some extra statutory concessions, and ESC C16 is one of the likely targets. Fears are now mounting that the government will take the opportunity to tidy-up this apparent anomaly.

There are rumours that the £4,000 monetary limit will be retained, but be utilised in a far broader way. It would not be difficult to imagine the government retaining the concession for the very smallest of companies only by allowing capital treatment where the share capital and reserves fall below this figure but insisting on a formal winding-up or making distributions subject to income tax for “larger” companies with net assets above this figure.

So if you are thinking of taking advantage of the current concession there is no time to lose as the opportunity may close as early as Budget day on 23 March.

Four thousand pounds is hardly a king’s ransom and this figure might increase. But in a world where someone earning £8,500 is still referred to as a “higher-paid” employee, I wouldn’t bet on it.

Andy White is a tax partner at
accountancy firm CBW. He can be contacted at andy.white[at]cbw.co.uk, or on Tel: 020 7309 3800.

Replies (12)

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By jamesbailey
24th Feb 2011 16:13

ESC C16

The £4,000 limit on distributions treated as capital is more than a rumour - it's right there in the draft legislation - see subsection (5) of the proposed new section 1030A of CTA 2010, published in the condoc..

It is particularly distasteful that this is to be brought in by way of a Treasury Order under Section 160 FA 2008, rather than being exposed to full parliamentary scrutiny as part of the Finance Bill 2011.

The consultation period ends on 7 March, so there's still a little time to make your objections known.

James Bailey

Tax Partner, Robinson Reed Layton

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Nichola Ross Martin
By Nichola Ross Martin
28th Feb 2011 11:16

Its probably too late

As you point out, this consultation commenced in January and you need to reply by 7 March.

The tax bodies are all responding to the consultation. HMRC's case is that firms have been abusing ESC C16 and so it must go.

A geninue pity, because look at this example:

Mr and Mrs B have run a corner shop for many years, they trade via a limited company. They want to sell up for £100,000.

If they dispose of their shares to Mr Buyer, they will receive Entrepreneurs' Relief on the capital gain they make on the disposal of their shares and pay tax at just 10%

If their company disposes of its trade to Mr Buyer, the company will make a capital gain and the couple will face double taxation as they extract the funds from the company as dividends, or if they appoint a liquidator, who say charges £10,000 for the job, they will be able to extract funds as capital but at the extra cost of £10,000.

With ESC C16 intact that £10,000 extra cost could have been avoided.

That does not seem too fair does it?

Virtual tax support for accountants: www.rossmartin.co.uk

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By DavidW878
28th Feb 2011 11:33

Why?

Actually, in my day it was the number 77 that went to Nether Wallop.  But not very often.  Usually you had to get the number 76 to Middle Wallop and walk from the George.

More relevantly, it's difficult to know whether this is [***]-up or conspiracy.  The Treasury Solicitor practice is concerned only with unlawful distribution, so the £4,000 applied by the Treasury Solicitor applies to share capital, share premium and other non-distributable reserves.  Since a lawful reduction of capital is now fairly straightforward, in practice it is not difficult to ensure that any unlawful distribution is under £4,000.  The draft legislation refers, however, to the total amount to be distributed before strike-off (i.e. including reserves) and rather than bringing tax law into line with TS practice will in fact enshrine a difference.  Whether this is because HMRC have misread the TS practice or whether they carry a candle for the insolvency industry I cannot tell.  But it's disingenuous to suggest that this has anything to do with tax avoidance.  All ESC C16 has done is allowed companies to avoid the cost of appointing a liquidator.  That is not "tax abuse".    Whether my comments to HMRC along those lines will bear fruit remains to be seen.

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By Paul Soper
28th Feb 2011 12:42

Misunderstanding?

I too wonder if this is misunderstanding by the parliamentary draftsperson, whoever that might be, but to restrict the use of the statutory equivalent of C16 to 4,000 pounds, as stated not a rumour, but a specific condition of the use of this mechanism, makes it almost completely useless if it is deliberate.  I think we neecd a concerted campaign, a bit like income-splitting a couple of years ago, to force both HMRC and MPs to realise just how ridiculous this proposal actually is.. If they receive hundreds, or better still thousands of protests, rather than 30 or 40 from the usual suspects which is more typical of consultation they might think it over.  I've already written to HMRC, time to hit my MP next.

 

 

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By cfield
28th Feb 2011 12:50

Tax abuse

Anything seems to be tax abuse these days to HMRC and to certain politicians who don't know (or pretend not to know) the difference between evasion and avoidance. We hear all the time about the need for people to pay "the right amount of tax" which is usually what these people unilaterally think it should be rather than what the law actually says. However, that also means people shouldn't pay too MUCH tax. For example, a sole trader whose wife helps out in the business but who never claims wages for her. We never hear them complaining too much about that, do we?

Re ESC 16, I think the tax abuse HMRC is concerned about are all those shysters who close down one company and then immediately start up another. Very difficult to police that. It would seem that it is those people who are ruining it for everyone else. As always, it is the innocent and law abiding who ultimately suffer! 

Chris

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By cfield
28th Feb 2011 12:59

Let's tell everyone!

Maybe we should get the media involved. If this new "stealth tax" is mentioned on the BBC News, then the whole business community will find out and hopefully there will be a storm of protest. It has a similar affect in many ways to the abolition of taper relief a few years ago. The Government made damn sure that was publicised because they wanted people to see that were doing something about all those private equity managers paying less tax than their cleaners. What they didn't expect was the uproar that followed from self-employed people about to retire, so Darling had to bring in entrepreneurs relief as a sop, which he obviously never intended. Perhaps we can achieve a similar result this time.

Chris

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By Paul Soper
28th Feb 2011 13:35

Abuse?

It is only right that HMRC should seek to root out abuse, for some time now people trying to use C16 have been asked to confirm that they are not closing down one company to simply open up another whilst extracting income as capital.  But sure this could be addressed by one of HMRC's favourite Targeted Anti Avoidance Rules so that the shiny new statutory C16 cannot be used where it is part of a scheme for the avoidance of liability.

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By leon0001
28th Feb 2011 14:34

Olden times

The photo depicts a Leyland Atlantean in London Country green and yellow. It must have been taken between 1972, when it was new, and about 1975. This bus was probably scrapped over 20 years ago.

Does anyone remember when ESC 16 was first introduced?

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Nichola Ross Martin
By Nichola Ross Martin
28th Feb 2011 18:22

Clearance proceedure

HMRC could just tighten up the clearance process, or as you say, Paul, add another anti-avoidance rule in order to sort the wheat from the chaff, so to speak. I feel that this would fit in nicely with the Transactions in Securities rules

I was the one who originally wondered if it was a [***]-up but I gather it is all "conspiracy"; HMRC claims that it does not have the manpower to police it ESC C16 anymore. Anyway keep shouting about this. Apart from anything I think it amounts to state aid in favour of the insolvency profession.  Why does HMRC want to do them a favour all of a sudden?

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By Paul Soper
28th Feb 2011 18:38

Pulling the wool over Parliaments eyes?

As mentioned I have now written to my MP, and a friend at the BBC, and Money-Box on Radio 4 - it was lunch-time honest - but I am sure that any MP who consults the consultation document will read the following words and tell us we have nothing to worry about.  I quote from the introduction to the document:

"Scope of this consultation:
This is a technical consultation to ensure that the draft legislation successfully preserves the current tax treatment under the ESCs concerned. Most of the legislation is by Treasury Order made under an enabling provision at section 160 of the Finance Act (FA) 2008, while some is made under powers that existed before the 2008 enabling provision was enacted.
Impact Assessment:
The intention is to do no more than put the existing concessionary tax treatment on a statutory basis so it is expected that there will be no, or only a negligible, impact and therefore an Impact Assessment is not required."

If restricting the limit to 4,000 pounds is that then what constitutes a significant change?

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By Huw Williams
03rd Mar 2011 13:20

But it was a concession

Whilst I agree that the change is unwelcome and goes further than just enacting C16, I wonder if we have forgotten that C16 is a concession.  There was nothing in statute to allow us to break company law (it is an illegal distribution isnt it?) and get away with beneficial tax consequences in this way - it was always a concession.

Maybe we should point out that one of the "costs" of incorporating a business is the potential for double taxation if the business is sold.

An alternative would be to lobby for a cheaper insolvency route than liquidation - but I expect there would then be complaints about removing safeguards....

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By Paul Soper
03rd Mar 2011 16:52

Missing the point?

Huw, you might be missing the point here.  Suppose a company had share capital of 1,000 and reserves of 99,000.  We all know that company law permits a dividend of 99,000 and all C16 ever did was to allow us to treat that perfectly legal dividend of 99,000 as a liquidators distribution by satisfying the conditions of C16, and it is worth noting that concessions cannot be used to avoid liability. That left the problem of the non-distributable reserve of 1,000 which is where the Treasury Solicitor enters the story a couple of years ago and allows non distributable reserves of up to 4,000 to be added to the legal dividend (allowing us to extract 100,000 in the example above) to avoid the unnecessary costs of appointing a liquidator.

What HMRC propose is NOT a continuation of the existing ESC C16 but a completely new statutory rule that will limit the amount capable of being extracted under C16's statutory equivalent to no more that 4,000.  And that is the point, either someone in HMRC has misunderstood the Treasury Solicitor's 4,000 which can be added to the C16 distribution, or this is a deliberate attempt by HMRC to misuse this process (THEY say this will not change the concession's application) to limit, not only the use of C16 but the whole process of seeking to have, or allowing a company to be struck off, and that is very clearly Parliament's intention because it has provided this mechanism in many earlier versions of company law - if Parliament does not want this process to be used then Parliament should change the law, and not in this rather underhand way.

This is great for liquidators as has been observed, but lousy for the small business.  It only needs a TAAR to prevent it being used for avoidance purposes.  It would seem that HMRC now interpret avoidance as any situation where the law permits two different liabilities to arise, choosing the lower liability is automatically avoidance.  Change the rules? Of course they can, they can move the goalposts at any time, because it is their playing field, but do it openly after proper debate, not by sneaking the change through under an assurance to Parliament that this is not intended to change anything.

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