Proposed changes to the treatment of distributions in a liquidation

5 January 2016

As part of the Summer Budget 2015, the government announced that it would publish a consultation on company distributions rules. This consultation has now been published, accompanied by draft amendments to the  legislative clauses (the transactions in securities rules) and the proposed introduction of a Targeted Anti-Avoidance Rule (TAAR) in relation to certain arrangements for converting income to capital, both applying from 6 April 2016.

It is proposed to amend the Transactions in Securities (TIS) rules from April 2016 in order to introduce a connected parties rule and also change the counteraction rules so that they operate in a similar fashion to the self-assessment compliance rules.

The proposals look to tackle some situations where HMRC believe company owners are abusing the rules and potentially receiving capital for their interest in their own company.  They include:

  • A disposal of shares to a third party where a cash balance is left in the company in order to increase sales proceeds and so, in effect, turn cash into capital;
  • A purchase of own shares (for unquoted companies) where the seller retains sufficient interest in the company to block a special resolution;
  • A capital distribution made in a winding-up, in cases where:
    • A company has been used as a moneybox;
    • The owner is setting up ‘phoenix’ companies; and
    • A company is a special purpose vehicle.
  • Repayment of share capital (including share premium) following a reorganisation.

Impact of the proposal

At present, the general rule is that (unless certain anti-avoidance legislation is invoked by HMRC) any distribution in a winding-up is charged to Capital Gains Tax (CGT) in the hands of an individual.  The rate of tax may be as low as 10% if Entrepreneurs’ Relief is available and will be a maximum of 28%.

Under the new proposals, a new TAAR will be applied to certain distributions from a winding-up which would treat them as income distributions (chargeable to Income Tax, at rates ranging up to 38.1%) where:

a) The company is a ‘close company’ (or has been such a company within the previous two years). This will include most privately-owned companies;

b) Within two years after the date of the distribution, the individual receiving the distribution (or someone connected with him or her) is involved in carrying on any trade or other activity previously carried on by the company (or any similar trade or activity); this could, for example, be a sole trader or via a partnership LLP or new company; and

c) It is reasonable in all the circumstances to assume that one of the main purposes of the liquidation (or arrangements of which the liquidation forms part) is the avoidance of Income Tax. For this purpose the fact that Condition B is met is regarded as a relevant circumstance.

A specific exemption would apply where all of the assets that are distributed to the person consist of irredeemable shares in a subsidiary of the company being wound up. This is intended to prevent liquidation demergers of close company groups falling within the new TAAR.  This measure is proposed to apply to distributions in a winding up made on or after 6 April 2016.

It would be advisable to review all liquidation or return of capital demerger transactions in progress, or contemplated, to establish whether they may potentially be within the scope of the draft legislation and, if so, whether action should be taken to complete such transactions before 6 April 2016, when the legislation is currently scheduled to take effect.

For further advice on any of the above or to discuss your specific circumstances, please contact our specialist, Reshma Patel.