HMRC Put a Spotlight on Phoenixing
HMRC have published their new spotlight (47) expressing their discontent with schemes that seek to bypass the targeted anti-avoidance legislation commonly referred to as the ‘phoenixing provisions’.
Those who have participated in such schemes should be cautious of challenge by HMRC, particularly in light of their recent approach to perceived avoidance schemes. The spotlight also prompts much needed clarity on the scope and application of the TAAR, clarity which might only be received by litigation.
The Rise of the Phoenix
Before April 2016, taxpayers – typically contractors – could extract profits from their company at the capital gains tax rate of 10% by winding up their company. The winding up of a company invoked specific taxing provisions which treat any amounts received as a capital receipt, as opposed to an income dividend.
This incentivised taxpayers to build up funds within a company with the view to winding up the company, extracting the profits via a lump sum payment and paying tax at 10%. They would continue their previous business activities via a new company and repeat the cycle.
This practice is commonly referred to as phoenixism – the act of forming and dissolving a company whilst continuing to operate the same underlying business via a new vehicle.
Following a government consultation in 2015, this practice was deemed unfair as it allowed certain individuals as businesses to benefit from lower rates of tax.
As such, the phoenixing provisions were introduced to remove the tax advantages and ultimately redress the balance.
Another driving factor to contain these practices is that these taxpayers were effectively converting their income, which should be taxable as income, into capital, something that HMRC are particularly unfond of.
This type of planning was not generally considered to be ‘tax avoidance’ but rather prudent and reasonable planning. HMRC, tax professionals and advisers were fully aware of this practice, and it was generally accepted and recommended where appropriate.
However, in other areas of law, phoenixism is generally undesirable. For example, it is more difficult to bring a legal claim against a company which has been dissolved. Negligent or fraudulent traders could attempt to exploit this by phoenixism. Although, there are undoubtedly company law provisions which seek to deter this.
The Demise of the Phoenix
The introduction of Targeted Anti-Avoidance Rules (“TAAR”) in April 2016 – adequately dubbed the phoenixing provisions – saw the death of the phoenix.
This sought to tax receipts extracted by way of a winding-up as income at rates of up to 38.1%, thus removing any tax advantage. However, this only bites where:
1) the individual is involved in carrying on a similar activity within two years of the winding up; and
2) If the main purpose, or one of the main purposes, of the winding up was the avoidance or reduction of tax.
This attempts to secure that the legislation targets the perceived abuse – i.e. phoenixism
In Harry Potter and the Chamber of Secrets, Dumbledore’s phoenix helpfully blinds the basilisk, disarming its petrifying gaze.
Something the basilisk and the legislation phoenixing provisions have in common is something short of 20/20 vision.
The drafting of the legislation is vague and professional advisers and their institutions are not clear of the scope and application of this legislation.
To put it bluntly, advisers are not clear of the precise circumstances which are caught.
One particular example is the definition of ‘a similar activity’. This phrase has the potential to be applied both broadly and narrowly, and it is not clear what types of activity would be caught. HMRC have provided some guidance, but this is unhelpfully brief.
Indeed, this was brought into question during the governments consultation period. It was suggested by the industry that a clearance service is introduced to help alleviate any uncertainty.
However, this was refused and instead an offer of HMRC guidance was considered sufficient. However, three years later HMRC still receives criticism on the clarity that guidance supposedly provides.
The spotlight is, in essence, HMRC publicly throwing down their gauntlet to challenge and raise awareness of scheme’s which seek to bypass the phoenixing provisions.
‘They claim that by making an artificial modification of the arrangements aimed at defeating the intention of the legislation the TAAR will not apply’
The spotlight is, like the guidance, unhelpfully brief. The single sentence example given by HMRC considers the sale of shares in the (cash rich) company to a 3rd party instead of winding it up themselves.
HMRC consider such arrangements to fall within the scope of the phoenixing provisions. However, reading the legislation, it is designed to deal with winding up a company, not a sale of shares – a square pegs and round holes analogy, if you will.
The legislation is designed to deal with a winding up, not a share sale. As such, it is arguable that the arrangement does not fall within the legislation.
However, HMRC are clearly taking a wide and purposive approach to the legislation arguing that:
1) The actual outcome is that the individual is receiving a distribution and continues to trade using a different vehicle;
2) These schemes are within the scope and purpose of the legislation; and
3) Phoenixism arrangements are caught
In pre-empting the potential arguments against this, HMRC have also stated that they will consider whether the General Anti-Abuse Rules (“GAAR”) can be invoked.
However, this may be a difficult position to sustain, particularly as the only successful GAAR opinions are in relation to highly egregious schemes. I question whether the example given could be considered of a similar calibre.
Ultimately, HMRC have made their position clear. Any participants in schemes which attempt to get round the phoenixing provisions should be cautious of any challenge by HMRC. Particularly in light of their aggressive approach to perceived avoidance, as noted by various institutions and organisations, including the House of Lords.
With HMRCs apparent litigation strategy, I would expect that a test case is being sought by HMRC. This would certainly be welcome by many advisers, as the courts may provide some much needed clarity on the scope and application of the legislation.
For more info on any of the topics raised above please contact our team of helpful tax advisers. You can also read more about Capital Distribution on Liquidation or check out more articles about anti avoidance below.