In company law, a distribution in respect of share capital during a winding up is not currently treated as an income distribution for tax purposes, instead being subject to capital gains tax. This means a maximum rate of tax of 28%, falling to as low as 10% if entrepreneurs’ relief is available.
The government is concerned that this is being exploited by tax planners in three main areas: ‘Moneyboxing’ whereby shareholders retain profits in excess of a company’s commercial needs in order to draw as capital on liquidation; ‘Phoenixism’ or the act of winding up companies to receive the value as capital before setting up new companies to carry on substantially the same business and ‘Special purpose companies’ where business operations are separable and a company is incorporated for each, allowing them to be liquidated at a project’s end and the project’s profits realised as capital.
Subject to conditions, proposals in The Finance Bill 2016 for a new targeted anti-avoidance rule would see capital released after 6 April 2016 from a company in liquidation taxed as income, as with a dividend, potentially leading to tax rates of 32.5% for higher rate tax payers and 38.1% for additional rate tax payers.
The three conditions that must be met are: that the company be a close company (broadly five or fewer participators, ie. most privately-owned companies) or has been such within two years prior to the liquidation; that within two years of the distribution the recipient, or a connected party, is involved in the carrying on of the trade of the wound up company or any similar activities, whether as an individual or via a corporate entity and that it is reasonable to assume one of the main purposes of the liquidation was the avoidance of income tax. There are two exclusions to the proposed rule, namely if the amount distributed does not exceed the amount originally subscribed for the shares or if the distribution is of a shareholding in a subsidiary company.
Figures from the Autumn Statement 2015, certified by the Office for Budget Responsibility, show the projected impact on the exchequer being negligible in the year 2016/17 but causing an increase in revenues of £35 million in 2017/18 and a further £45 million over the following three years. One industry that may be particularly affected is property development. Currently, most small developers set up a new company for each property being developed, often for legitimate commercial reasons such as a difference in the funding of the projects or the use of alternative construction service providers, the company is then dissolved and the capital released. The significantly higher tax rates envisioned by this proposed rule would squeeze profit margins for developers at a time when the government is pushing for more new homes to be built.
The proposed rule gives business owners a huge incentive to wind up companies and implement a capital distribution before 6 April 2016, although care must be taken regarding the condition restricting carrying on the same trade in the two years subsequent. Should you be in a position to take advantage of this before the change we encourage you to contact us and speak with one of our experienced Practitioners who will be more than happy to provide guidance and advice. An initial consultation is provided free of charge.