HMRC have recently published a consultation document, alongside proposed draft legislation, which, if enacted, will bring about significant changes to the tax treatment for individual shareholders receiving a distribution from a members’ voluntary liquidation (MVL).
HMRC are concerned that individuals can pay a lower tax rate by extracting profits by way of liquidation, as opposed to simply receiving a dividend, and are particularly concerned that the perceived problem may escalate when tax rates on dividends change on 6 April 2016.
HMRC’s consultation document deals with two ‘problems’ in particular:
- “Phoenixism” – this is where a Newco is established to carry out substantially the same activities and has substantially the same ownership structure, whilst the original company is liquidated and the profits extracted in capital form.
- “Moneyboxing” – this is where a company deliberately retains an amount of profit which is in excess of its working capital requirements, such that shareholders only receive profits when the company is eventually liquidated.
What is proposed?
ITA 2007, s698 already gives HMRC a general power to strike when income is converted into capital, but the consultation document sets out new proposals designed to create specific rules for liquidations. The effect of this for the taxpayer is that some individuals could see their effective tax rate on exit increase from 10% to just over 38% after 6 April 2016.
The proposal is to introduce a targeted anti-avoidance rule (TAAR) which would reclassify a liquidation distribution as income in certain circumstances. It will up to the taxpayer to self-assess whether they are affected by the TAAR.
The TAAR could well apply, for example, where a close company (one controlled by five or fewer shareholders) is liquidated and the shareholders continue to be involved in the same or a similar business within the next two years, (although only where the purpose of the arrangement is to obtain a tax advantage). It is believed that liquidation demergers effected under S110 Insolvency Act 1986 for bona fide commercial purposes will not fall foul of the new legislation.
The new legislation is expected to be included in Finance Act 2016 and will apply to any and all distributions taking place on or after 6 April 2016 (regardless of when the liquidation itself occurs).
For those making distributions under current MVLs or planning to do so, the time to act is probably now, particularly when you consider that it would be usual for formal clearance to be sought when going down the route of an MVL, which can take 30 days or more to come through.
It might appear that the a window of opportunity is beginning to close for, say, the likes of property developers who traditionally develop through special purpose companies, crystallise the profit and then wind up the Company extracting the cash as a capital distribution.
However, as things stand, we think there are still routes available, even after taking in to account these new rules, that would allow such an entrepreneur to access the same commercial and tax benefits.
If you will be affected by these changes then please do not hesitate to get in touch with us.