HMRC introduced a Targeted Anti-Avoidance Rule in Finance Act 2016 to counter the practice of winding up a company for tax avoidance purposes, specifically attempting to convert dividends into a capital payment.
HMRC have now published guidance (see here ) to indicate the circumstances in which the anti-avoidance rule would be invoked leading to the extracted profits being subject to income tax rather than the hope for capital gains tax.
HMRC give an example of such a practice
Mr J is a dance instructor who runs his business through his own company. At the end of each year, instead of paying himself a dividend (which would be liable to Income Tax), Mr J winds up his company and receives the profits as a distribution in a winding up, liable to Capital Gains Tax. He then immediately creates a new company and continues his dance instruction business.
This practice is often known as ‘phoenixism’ (because the new company rises from the ashes of the old).
The example given is straight forward but it comes as no surprise that the guidance covers more sophisticated methods of attempting to extract profits from the company at capital gains tax rates where the owners intend to carry on the business albeit in a new guise.
HMRC say in their guidance
Ultimately, the legislation is asking whether the individual that has received the distribution is continuing what amounts to the same business, having extracted the accumulated profits in a capital form. This is inevitably a question of judgment to be made on the basis of facts in individual cases. The following issues are likely to be relevant:
- Is there a tax advantage, and if so, is its size consistent with a decision to wind-up a company to obtain it?
- To what extent does the trade or activity carried on after the winding-up resemble the trade or activity carried on by the wound-up company?
- What is the involvement in that trade or activity by the individual who received the distribution? To what extent have their working practices changed?
- Are there any special circumstances? For example, is the individual merely supplying short-term consultancy to the new owners of the trade?
- How much influence did the person that received the tax advantage have over the arrangements? Is it a reasonable inference that arrangements were entered into to secure this advantage?
- Is there a pattern, for instance have previous companies with similar activities been wound-up?
- What other factors might be present to lead to a decision to wind-up? Are these commercial and independent of tax benefits?
- Are there any events apparently linked with the winding-up that might reasonably be taken into account? For example, was the only trade sold to a third party, leaving just the proceeds of the sale?
Clearly a business can come to the end of its useful life, for example, as a result of:
1. The shareholders reaching retirement
2. Loss of business
The shareholders may then consider winding the company up and distributing any assets, including cash, to themselves. Generally that would result in a capital gains tax liability arising where the value of the assets received exceeds the base cost of the shares. The rate of tax payable, after taking into account the annual exemption, will depend on whether or not entrepreneurs’ relief is available.
In those circumstances where there is no continuing business activity it is unlikely that HMRC would invoke the anti-avoidance rule.
As always when contemplating change in business circumstances professional advice should be sought.