HMRC have published Spotlight 47, which provides guidance on tax avoidance schemes that try to avoid the income tax charge on distributions when a company is being wound up.
In recent years, HMRC have endeavoured to prevent schemes being used by shareholders to take advantage of more favourable capital gains tax rates when extracting value from their company.
Until 6 April 2016, under arrangements known as ‘phoenixism’, an individual shareholder who intended to carry on the company’s activities could arrange matters enabling them to wind up the company and receive the company’s undistributed profits. The profits would be classed as capital distribution (subject to capital gains tax rates), rather than a dividend or other income distribution (subject to higher income tax rates). The individual would then carry on the same or similar activity, often using a newly-formed company.
To counter this perceived avoidance, in 2015 HMRC introduced Targeted Anti-avoidance Rule (TAAR) legislation to prevent individuals from gaining a tax advantage by winding up companies, to make sure any distribution in the winding up is taxed as income, rather than being subject to capital gains tax.
Some scheme promoters have recently claimed that they can get around the TAAR legislation by making an artificial modification of the arrangements (for example by selling the company to a third party rather than winding it up). However, HMRC are adamant that such schemes do not work because:
- in many cases, the actual outcome is that the individual is receiving distributions in a winding up – as the individual carries on trading using a different vehicle these schemes are within the scope and purpose of the TAAR legislation; and
- phoenixism arrangements that claim to involve payments to shareholders taxed as capital instead of income are caught by the TAAR, or other provisions.
HMRC have said that they will investigate any attempts to avoid the income tax charge. If it is claimed that the phoenixism TAAR does not cover the arrangements, HMRC will consider whether the General Anti-abuse Rule (GAAR) applies to these schemes.
HMRC have reaffirmed that a severe penalty regime exists in relation to such schemes – transactions after 14 September 2016 where the GAAR applies will be subject to a 60% user penalty. Moreover, for transactions entered into on or after 16 November 2017, any person who enabled the use of these sorts of schemes may be subject to a penalty as an enabler of an abusive scheme. The penalty amount will be equal to the amount of consideration they received for enabling the arrangements. The user may also be subject to penalties for filing an inaccurate return, with penalties of up to 100% of the undeclared tax.
For further information, see HMRC Spotlight 47 here.