A common scenario at any stage in the life of a private limited company would be shareholders contemplating retirement and therefore extraction of funds is on the agenda.
Sounds straightforward enough? Accountants advising clients know that this issue is far from straightforward- with various options, all of which are subject to HMRC rules and regulations.
To complicate matters further, HMRC has recently introduced Targeted Anti-Avoidance Rules (TAARs) in the 2016 Finance Bill which seek to address what they see as tax avoidance relating to certain aspects of the retirement process.
A normal retirement case
Although the distributions rules are complicated, a simple scenario might be where a company is wound up and a distribution is made. Depending on the details the shareholder would pay capital gains tax at either 10% or 20% on the distribution as it would be treated as capital. This may work to the taxpayer’s advantage as treating the distribution as a dividend might incur a higher income tax charge.
However, consider the following examples:
- The shareholder quickly starts up a new company, accumulates wealth in it, and then winds up the company again. Potentially the tax savings are the same each time he does this.
- The shareholder genuinely retires but quickly realises that he does not like the sedate life so starts up as a sole trader involved in the same trade.
The effect of the new TAARs
HMRC refers to the above as ‘phoenixism’ where the company is wound up and yet the same trade is then carried on either in a new company or in a different vehicle. The TAAR will treat a distribution from a winding-up as if it were an income distribution for the purpose of section 1000 CTA 2010 where certain basic conditions are met. These conditions are:
- an individual (S) who is a shareholder in a close company C receives from C a distribution in respect of shares in a winding-up
- within a period of two years after the distribution, S continues to be involved in a similar trade or activity
- the circumstances surrounding the winding-up have the main purpose, or one of the main purposes, of obtaining a tax advantage
(note that the above provisions do not apply to minority shareholders).
The ‘grey’ areas
Clearly the legislation is aimed at repeat ‘phoenix’ companies where a tax advantage is planned for. However, HMRC has not clarified what it means by a ‘similar’ trade. If it is exactly the same this would be obvious but where a client decided to try their hand at something different but broadly related, how would this be treated?
In addition HMRC use the phrase ‘involved’. Clearly if the former shareholder was the owner of a new company then they would be caught under the above provisions. But for instance would helping a friend or relative set up a new business and retaining a minority interest be caught?
The third contentious area is the type of business vehicle to be used after the winding up. The legislation does not necessarily only apply to a new limited company. It could also potentially apply to a part time sole trader business in the same trade.
The intention to gain a tax advantage
It is always important to remember that if the intention is clearly not to avoid tax then the TAAR is not effective.
Conclusion
In the effort to tackle tax avoidance the legislation will have created confusion and uncertainty for some business owners who are thinking of retiring. When you are advising clients on such issues ensure that they plan ahead. In particular applying for advance clearance may be useful.
Article from ACCA In Practice