It is always amusing when the law is changed and made “clearer” and then with hindsight (whoops) it isn’t quite (or drastically nowhere near) right. That was the case (according to HMRC) with company distributions and whether they were within the scope of capital gains tax (“CGT”) or income tax.
By way of history….
In 1985, Extra Statutory Concession C 16 (“ESC C16”) was introduced to provide clarity on the tax treatment for shareholders where a company was being struck off, with the company’s assets, including cash, being returned to the shareholders. The concession did not prevent shareholders seeking CGT treatment on the distribution
Twenty seven years later (the life of an Inspector) legislation was introduced to not only bring clarity but to prevent tax avoidance. Obviously this was one of the more speedy reforms to be considered.
ESC C16 was replaced by legislation which came into effect from 1st March 2012; the new legislation effectively imposed a maximum cap of just £25,000 for CGT treatment or the requirement that a liquidator be appointed.
Where total reserves available for distribution exceed £25,000, shareholders may suffer income tax rather than capital gains tax on the entire assets distributed as part of the winding up of the company. It is worth noting that the limit applies only to reserves and not share capital distributed.
A Members Voluntary Liquidation (MVL) enables the formal winding up of a company’s affairs with all of the assets being distributed; the distribution, regardless of value, will automatically be a capital distribution in the hands of the shareholders. If the company were a qualifying trading company, Entrepreneurs’ Relief would have been available. The changes were quite clear and therefore no amendments were expected – after all thirty one years appears to be plenty of time to decide what is required.
HMRC have issued a consultation document and draft legislation on company distributions. The new rules intend to offer clarification, although one can’t help to think this could have been achieved in 2012 or the preceding twenty seven years. There are many changes proposed in the consultation although this article concerns itself with distributions on winding up.
The distribution of assets to an individual when a company is wound up may be treated as an income distribution where the following three conditions are met:
- A company is a close company when it is wound up or at any time in the two years before the start of winding-up
- Within two years of the distribution the individual carries on a similar or the same trade or activity as was carried on by the company
- The individual or a connected person is a participator in a company that carries on such a trade or is connected with a company carrying on such a trade or activity
- The individual is involved with the carrying on of such a trade or activity by a connected person
- It is reasonable to assume, having regard to all the circumstances, that a main purpose of the arrangement was the avoidance of income tax
So the intended purpose is to combat phoenixism and also to target the situation where a separate company is established for each project. In many circumstances the application of the proposed legislation may entirely fall down to the interpretation or view of what constitutes a similar trade or activity and what is a tax avoidance motive.
The real concern and risks is the probability that HMRC views will differ substantially. Care therefore needs to be taken with any MVL; we feel a prudent approach would be to clearly document at the outset the reasons and rationale as well as to analyse the tax consequences.