Apologies for the dreadful pun. Not only dreadful but dated. I am informed that the St Louis Cardinals have not been the Phoenix Cardinals since 1994.
Unfortunately, things get no better from this point forward as this is largely an update on one of our earlier articles.
The Finance Bill contains provisions that will bolster the Transactions in Securities rules and apply to distributions made on a winding up. This will effect so-called ‘Phoenix’ Companies and ‘Money-box’ companies. Despite not yet receiving Royal Assent, and this is not now expected until September, these rules have essentially already taken effect.
The impact of the changes – a recap
Prior to the changes, where a distribution was made in pursuance of a solvent liquidation (“MVL”), the resulting capital distribution would usually be brought within the capital gains tax regime.
The new changes will impact distributions made post 6 April this year where certain conditions are met.
Where these rules do apply, they will seek to tax the distributions made under a MVL as an income distribution rather than a capital distribution. Effectively the member is treated as receiving a normal dividend. The tax rates then become a little more eye watering!
Since our last article on this subject, the conditions have been tweaked a little:
- Immediately before winding up, an individual holds a 5% interest. It had previously been described by HMRC that minority shareholders would not be caught by the rules. This looks more like a ‘materiality’ test rather than a ‘minority’ test!
- The Company is close or would be close if it was UK resident when it is wound up
- Within two years of the distribution, the individual carries on a similar trade or activity (whether as an individual, partner or via a close company)
- It is reasonable to assume:
- A main purpose of winding up was avoidance or reduction of the charge to income tax;
- The winding up forms part of arrangements, a main purposes of which is avoidance or reduction to the charge to income tax
It is probably fair to assume that in respect of condition 4, HMRC will seek to argue that if a pre liquidation could have been paid but was not, this was part of an arrangement made with the company by its shareholders the main purpose of which was to avoid income tax.
The absence (at the time of writing) of a clearance procedure where one can obtain an advance assurance from HMRC that a transaction is for commercial purposes is glaring. We are aware that the profession are lobbying for this as we write.
Who will be effected by these rules?
Who are the naughty boys to be sent to the back of the class by these proposals?
It seems that there are potentially two areas, in our view, where these provisions are intended to bite. The first are so called contractors. Essentially businesses which are set up and have little substance other than an individual who applies their own skills and knowledge through a Limited Company.
In such circumstances, they can quite easily be self-employed and avoid the raft of rules which apply in this area (eg IR35). However, some of these businesses will trade for a while, build up a cash balance of after tax earnings and then liquidate. The funds released, until now, being subject to Entrepreneurs Relief unless they were a bit too ‘regular’ in undertaking such a course of action.
The other potential area where this may impact is in the property development world. Here a particular development might be undertaken by a company setup for that particular purpose (often referred to as a SPV). Once the development is completed, and corporation tax paid on the profit within the company, the SPV is cracked open like the proverbial coconut with the insides subject to entrepreneurs’ relief.
The tax cost
Let’s say Jerry has a Company. He has historically operated a consultancy trade through the Company for a number of years. He now has £100k in the Company. He has substantial income from other sources and is already an additional rate taxpayer.
Prior to April 2016, he considers that a member’s voluntary liquidation was the best course of action. His corporation tax bill had long since been paid. So, after taking the cash as a capital distribution which was subject to Entrepreneurs’ Relief, he would net 90k. Not bad.
Shortly after, due to a pick up in the market, he decides to dust off his consulting shoes and start all over again
However, in a parallel universe, where his admin was not quite so good, his capital distribution in pursuance of the liquidation was not made until May 2016. Does this matter? Well, yes, and with significant tax implications.
Not only would the payment not qualify for Entrepreneurs’ Relief, but it would not be treated as capital at all (as he has already started a ‘phoenix business’). Instead, the return received would be taxed as an income distribution at the slightly more eye watering rate of, in his case as an additional rate taxpayer, 38.1%!
What can be done?
As stated above the rules, assuming no massive interventions prior to Royal Assent, have already taken effect.
As noted, historically property developers have looked to operate through SPVs for commercial reasons. For example, they wish to isolate the risk of a particular development within that SPV and not potentially polluting future projects. Of course, where this is the overriding purpose then it should not, on review of the conditions set out above, be within the scope of these targeted avoidance provisions. However, HMRC may have a different view and with no formal clearance procedure one is relying on HMRC providing a non-statutory clearance.
Alternatively, one might look to operate through a holding company which holds the shares in subsidiary SPVS who in turn carry out the specific projects. This would allow, say, SPV A to be liquidated on completion of project A after paying corporation tax, the holding company receiving the resulting distribution free of tax (as Corporates do not pay tax on the receipt of such distributions) and then reinvest the gross proceeds in new SPV B to commence project B.
Alternatively, one might look to effect a sale to an unconnected party (see below)
Contractors / other traders
It is unlikely that a contractor who is looking to act as he might have done prior to the rule change is likely to get clearance from HMRC under the route described above. If he wishes to dispose of the business, take the cash as a capital sum and avail himself of Entrepreneurs’ Relief then he must consider other means.
The easiest route would be to sell the shares in the Company to a third party. As there is no distribution on a winding up the rules will simply not apply. Of course, if there is an attractive business that could be operated as a going concern by a new owner, thena general third party sale may be in the offing.
Of course, in many circumstances, we might be talking merely about a cash box company with little prospect of an ongoing business. A sale to a trade buyer is therefore unlikely. However, it does seem extremely likely that finance companies would be prepared to offer some kind of facility to enable such shareholders to crystallise value in this way where such a company could make a turn.
If you, or your clients, would like to find out more then please do not hesitate to get in touch