Company distributions in a winding up
Tina Riches considers HMRC’s updated view on tax avoidance schemes that try to avoid an income tax charge on distributions when winding up a company, touching up phoenixism in the process.
ICAEW and CIOT recently met with HMRC to discuss Spotlight 47, which HMRC published on 4 February 2019. The Spotlight provides “information about tax avoidance schemes that try to avoid an income tax charge on distributions when winding up a company”. ICAEW and CIOT sought a meeting with HMRC with a view to better understanding HMRC’s position.
The relevant legislation is at s396B and s404A, ITTOIA 2005. It is a targeted anti-avoidance rule (TAAR), which treats distributions made to an individual in respect of share capital in the winding up of a UK resident company as a distribution subject to income tax, rather than subject to capital gains tax, if four conditions are met. Paraphrasing, the conditions are:
Condition A – the individual has at least a 5% interest in the company immediately before the winding up.
Condition B – the company is, or was, at any time in the two years up to the start of the winding up, a close company.
Condition C – at any time in the two years from the date on which the distribution is made the individual, or a partnership or company in which they are involved or a connected person, directly or indirectly, carries on a trade or activity which is the same as, or similar to, that carried on by the company or an effective 51% subsidiary of the company.
Condition D – it is reasonable to assume, having regard to all the circumstances, that the main purpose or one of the main purposes of the winding up is, or forms part of arrangements that are, the avoidance or reduction of an income tax charge.
The provisions apply to distributions in a winding up made on or after 6 April 2016. The professional bodies have previously commented that the legislation is widely drafted, and as a result has caused uncertainty over when, or if, it might apply.
The purpose of the TAAR is to stop someone avoiding income tax when they wind up a company and was introduced principally to tackle ‘phoenixism’, which is when a company goes into liquidation and a new company is set up to replace the old one with the purpose of carrying on the same, or substantially the same, trade as before. Without provisions to counter this, the shareholder receives the value of the old company in a capital form, while the trade continues exactly as before – albeit now in the new company. There is usually no commercial purpose behind the winding up and new formation.
The Spotlight goes on to say that HMRC is aware of phoenixism schemes that claim the TAAR will not apply “by making an artificial modification of the arrangements aimed at defeating the intention of the legislation (by selling the company to a third party rather than winding it up, for example)”. HMRC says that these schemes are within the scope and purpose of the legislation, and hence the TAAR does apply to them. It will also consider whether the general anti-abuse rule (GAAR) applies to these schemes.
During our meeting, HMRC explained that it had seen a change in behaviour since the introduction of the TAAR and this had prompted the Spotlight to be issued. Clearances received by HMRC showed instances of people selling companies rather than liquidating them, in an apparent attempt to avoid the TAAR.
HMRC confirmed that in some cases it considered that the TAAR could apply to such disposals. Where the TAAR might not apply, HMRC indicated that it is of the view that in some cases the GAAR could apply, presumably where the four conditions listed in the TAAR applied, though regarding a sale rather than a winding up.
Looking at the two extremes:
- If a business owner wanted to cease running their business and sold their company owning the business as a going concern to a third party and had no intention of working in this area again, then it is likely that the TAAR would not be in point. In such circumstances the sale to a third party would not usually change this.
- If a business owner wanted to liquidate one business and start a similar business (phoenixism), the TAAR is likely to be in point on liquidation. Attempting to avoid this by disposing of the assets and liabilities, turning the company into a money box, then selling this to a third party, who would liquidate it immediately and use the proceeds to pay the vendor, is likely to lead to HMRC thinking that the TAAR should apply. Then, even if a tribunal were to not accept that the TAAR applied, HMRC considers that it could invoke the GAAR due to a TAAR being deliberately avoided.
Between these extremes, HMRC indicated that the result of any case would depend on the particular facts, but we understood that the gist of their feeling was that selling shares in a company as an alternative to liquidation would be unlikely to reduce any uncertainties around whether the TAAR or GAAR would apply.
HMRC acknowledged that the scope of anti-abuse rules can lead to uncertainties and that ultimately addressing them is a matter for the courts. But it takes the view that the chargeable gains treatment of disposals of shares is in general confined to straightforward sales and company liquidation distributions untrammelled by tax considerations. It follows that HMRC will seek to apply anti-abuse rules in situations where the purpose of the legislation appears to be being circumvented and there is evidence that this is being achieved deliberately through what HMRC considers to be artificial means.
The commentary above is mainly taken from a meeting note that was agreed with HMRC (see practical point 134 in the June 2019 issue of TAXline). Practitioners will now be wondering what this means for their clients and how to advise them.
The key point is that HMRC seems to consider that selling shares in a company as an alternative to liquidation would be unlikely to reduce any uncertainties around whether the TAAR or GAAR would apply. In addition, although not specifically stated at the meeting, it seems possible that HMRC might consider that the TAAR would apply even if the money box company is not liquidated by the third party but kept as a dormant subsidiary.
The TAAR specifically refers to the distribution of share capital in a winding up of a UK company. It makes no mention of the sale of shares. Therefore, anyone who considers that there is a risk of the TAAR applying might in the past have considered whether selling the company as a money box might have reduced these uncertainties. This is now in doubt as HMRC appears to consider that it could be construed as including share disposals – where the four conditions are otherwise met.
Alternative views could be given on what the specific will of parliament was in this area and it is unclear whether the tribunals and courts would agree with HMRC’s view. Having discussed this with a few practitioners already there are some strong opinions that HMRC’s view is an extreme stretch in terms of both a purposive interpretation of the legislation and of the scope of the GAAR.
It is important to safeguard the rule of law in the context of the tax system, particularly in cases like this where we have seen no evidence that the original intention was to extend the TAAR to a sale of shares. It is also interesting that the GAAR panel has not, it seems, been asked for an opinion on any cases. HMRC appears very much in earnest in its intention to seek to apply the GAAR, if the TAAR fails. This risk of a challenge should not be underestimated, although there is strong doubt among experts about HMRC’s chances of ultimate success, except perhaps in the most egregious cases where the sale lacks any commercial consequence and is tantamount to a liquidation.
Members advising in this area will want to ensure that relevant clients are aware of HMRC’s updated views on this matter and the potential risks involved in pursuing a course of action on which HMRC has opined by way of the new Spotlight. Many clients will not wish to test this issue in the courts, as they will often seek certainty, even if it means erring on the side of caution.
The original shorter version of this article first appeared in Tax Adviser, and was written by Margaret Curran.
About the author
Tina Riches is chair of the CIOT’s OMB technical sub-committee