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.
As with everything else EU-related at the moment, it is hard to discern the full scope of the legal framework which will apply to UK businesses which succumb to financial troubles in the coming months and years.
The purely domestic legislation governing insolvency and restructuring is about to undergo some changes with a wholesale update of the Insolvency Rules. The current Insolvency Rules date back to 1986 and have been subject to revision on no less than 23 occasions since then. The new Insolvency Rules will come into effect in April 2017 as a fully revamped consolidation of the detailed rules which complement the broad provisions of the Insolvency Act 1986, which remains the central piece of legislation governing insolvent debtors (both corporate and individual) in the UK.
Of more interest and potentially greater impact (depending on the ultimate outcome of the Brexit negotiations with the EU) is the raft of new rules addressing companies in financial difficulty coming into play in Europe. The EC Regulation on Insolvency Proceedings 2000 (the Regulation) has been in operation since 2002 and has effected an ordered regime across the EU to address the affairs of an insolvent debtor which extend into more than one EU member state based around the concept of the debtor’s “centre of main interests” (or COMI). A recast and update of the Regulation is due to be implemented during 2017. This is designed to bolster the rules which support one of the central tenets of the Regulation, namely recognition across the EU of the laws of the member state where a debtor has its COMI – this has a direct bearing where there are cross-border elements concerning the debtor’s business, assets and creditors.
Supplementing the recast of the Regulation is another EU initiative by way of proposed directive on “preventative restructuring, insolvency and second chance”. The genesis of this has been the attractiveness of certain UK insolvency processes and rules, without equivalent elsewhere in the EU, which have driven a significant volume of insolvency and bankruptcy business into the UK and away from other EU countries. In other cases, such “forum shopping” has been driven by a desire to take advantage of more lenient insolvency and bankruptcy sanctions applicable here in the UK. The EU has responded with the directive which introduces a range of new EU-wide restructuring and pre-insolvency processes and principles drawing on domestic UK procedures and also the Chapter 11 rules in the US Bankruptcy Code. For example, the directive will introduce the concept of creditor “cram down”, a process whereby, say, a loan agreement stipulation that bank syndicate decisions must be made unanimously can be substituted for a lesser requirement for a majority vote instead. This cram down mechanism applies both in Chapter 11 insolvencies in the US and in schemes of arrangement here in the UK and serves to facilitate restructurings which are approved by a majority of, if not all, creditors, recognising that such arrangements can often involve determined hold-out creditors who threaten to scupper the broader interests of both the debtor and the majority of its creditors in favour of a proposed restructuring.
So what does all of this mean for the UK? It is hard to say. An overhaul of some of our domestic rules is overdue and welcome. Depending on what might ultimately be agreed by the Government in terms of a “hard” or “soft” Brexit and the timetable for the transition, the UK might well face a double whammy – being a less attractive forum for the restructuring of insolvent EU debtors whilst simultaneously experiencing regression in terms of future co-operation from EU courts and authorities as regards distressed UK debtors with European assets and / or liabilities as a result of the potential loss of our access to the Regulation and other pan-EU legislation. Only time will tell. Meanwhile, we will be sure to update you on the new rules as and when they are brought into force.
A recent case has shed some light on the question of what constitutes an effective surrender of a real estate lease. This was decided in the context of a tenant company in administration and provides some useful guidance on various factors to be borne in mind when contemplating a surrender. A short note summarising the position is attached for your information.
If you would like to discuss any aspects of this, please do contact Brett Israel.