The recent Finance Act 2016, which came into force on 15 September 2016, introduces a new “targeted anti avoidance” (“TAAR”) provision with a sweeping, and yet potentially unintended, scope in the context of company winding up.
The intention behind the new provision in section 35 of the Act is to ensure that the rules around the payment of tax on a distribution in a company winding up are not abused. Such a distribution, in the hands of the former company owner, will typically attract capital gains tax (CGT) as a gain on the return of capital at the rate of 10% or 20%. Conversely, dividend payments from the company would usually attract income tax at a much higher rate (potentially up to 38%).
HMRC considers that this tax differential is being exploited by close company stakeholders who contrive to wind up a company, pay a lower amount of CGT on distributions made to them and then start up a new company operating the same or a very similar business (and perhaps repeat the same process routinely). The new TAAR is focused on inhibiting such “phoenixism”. Unfortunately, the new TAAR rules have introduced significant uncertainty.
The TAAR rules apply to certain distributions made in the winding up of a UK company and where one or more of the shareholders has at least a 5% interest. The basic rule in section 35 applies where, within two years of the winding up, such a shareholder carries on, whether as a sole trader, partner or through another company, “a trade or activity which is the same as, or similar to” (emphasis added) the activities of the wound up company or any of its 51% subsidiaries (or is otherwise involved with a connected individual who is so carrying on such a trade or activity) and “that it is reasonable to assume that the main purpose or one of the main purposes of the winding up is the avoidance or reduction of a charge to income tax”.
There are several elements of this which are less than well defined. Whilst it should be fairly easy to tell whether one business is the same as another, it is much less clear whether one is “similar to” that other (or, more pertinently, whether HMRC would construe it to be). Being “involved with the carrying on” of a trade or business is very vague. On the face of it, the requirement for an intention to avoid paying income tax should be clearer, but this potentially goes right to the heart of many a winding up where the process is, per se, a tax saving measure.
Clear evidence of an intent to avoid income tax is one thing, but the provisions do not appear to recognise what is a fairly common commercial structure, namely the use of a once only special purpose vehicle for a particular project or site specific business arrangement. There are good reasons for structuring a project or arrangement in such a way. Can it fairly be said that the repeated use of such a process, with the winding up of the entity involved at the end of the project or arrangement, is indicative of an intention to avoid (or reduce) a charge to income tax?
A tax clearance process is provided for in the legislation, but HMRC have stated that it will not be used for the purpose of potentially clearing distributions in windings up subject to section 35. Instead, HMRC has indicated that it will publish guidance on the new rules which will focus on the areas of concern which have already been raised in the public consultation process and will include examples of the types of transaction to which TAAR it believes that TAAR will apply. It is, however, arguably unsatisfactory to have a situation where taxpayers will need to rely on non-statutory guidance for their relief where the scope of new rules is so broad as to potentially (and, one assumes, unintentionally) capture ordinary commercial transactions.