Changes to the taxation of distributions on a winding up

Changes to the taxation of distributions on a winding up

Tue 19 Jan 2016

The changes to the taxation of dividends from 6 April 2016 will see the differential between the rate of income tax on a distribution (up to 38.1%) and that of capital gains tax (as low as 10%, where entrepreneurs’ relief is available) at its greatest in recent years.

In anticipation of this, a number of draft changes have been announced in Finance Bill 2016 with regards to how individuals will be taxed on distributions received on a winding up.

1. Extension of the transactions in securities (TIS) legislation

The TIS legislation enables HMRC to counter transactions where distributions are extracted from close companies as capital, as opposed to income distributions, and where the main purpose was to avoid tax. Where these provisions apply, the individual will broadly be subject to income tax, rather than capital gains tax, on any distributions received, thus counteracting the advantage gained.

Until now, it has been accepted that a ‘simple’ liquidation (for example, on the winding up of a single company) has generally been outside the scope of this legislation, whereas a more complex liquidation (for example, resulting in assets being distributed to the shareholder and the shareholder being issued with shares in another company) could fall foul of it.

The changes announced explicitly bring all liquidations into the scope of the legislation.

This is a significant extension to the scope of these provisions, although ‘normal commercial transactions’ (i.e. those where the main purpose is not for the avoidance of tax) should be unaffected. It is nevertheless always recommended that advance assurance from HMRC be sought in all such cases to confirm that they will not impose these provisions on a transaction.

These changes will apply to any transaction which occurs on or after 6 April 2016, or all transactions within a series, where any one or more of them occurs on or after 6 April 2016. However, where a transaction falls on or after 6 April 2016, any clearance granted by HMRC under the current TIS rules will no longer be valid – so a new clearance would need to be sought under the new rules.  Therefore, it is preferable for winding-ups to be completed before 6 April 2016 where this could be problematic.

What transactions are likely to be affected?

This change will allow for HMRC to target ‘money boxing’ (where excess profits are retained in the company and extracted by way of capital on a liquidation) and ‘special purpose companies’ (where individual projects or contracts are carried out by separate companies so that on completion, they can be extracted by way of capital on a liquidation, instead of the extraction of regular dividends).

However, such transactions will only fall foul of this legislation where the main purpose of is the avoidance of tax.

2. Introduction of a new targeted anti avoidance rule (TAAR)

The new TAAR is being introduced which will tax certain distributions on a winding up to income tax, rather than capital gains tax, where these are made on or after 6 April 2016.

The TAAR is very widely drafted, but in broad terms, it will apply where a distribution is made to an individual on the winding up of a close company and within two years, that individual is somehow involved with a business carrying on the same or a similar trade or activity and the main purpose of the winding up was to reduce or avoid an income tax charge.

Distributions made to other companies on a winding-up are unaffected.

What transactions are likely to be affected?

This specifically targets ‘phoenixism’, where profits are retained within a company, the company is wound up (with the individual shareholders benefiting from capital treatment),  followed by any of the individuals setting up a business carrying on the same or similar trade or activity within two years of the winding up. These draft provisions are so wide they will even apply, if enacted as currently drafted, where the individual is only involved in the trade or activity of a business carried out by a person connected to him (such as a family member).

The TAAR may also catch ‘special purpose companies’ set up for individual contracts (as detailed above).

There are limited exemptions.  Firstly, the TAAR will not apply to cases where the assets distributed represent irredeemable shares in a subsidiary of the company – this would apply in the case of certain non-tax neutral demergers (i.e. where a holding company is liquidated, the shares of its subsidiaries are distributed directly to the individual shareholders, and the shareholders are subject to capital gains tax on the value distributed).  Secondly, the repayment of originally subscribed share capital is also excluded from the scope of the TAAR.

There has been a lot of speculation that these provisions could apply to non-statutory demergers (i.e. section 110 reconstructions), however, HMRC have confirmed to Mazars that the provisions within the TAAR are not intended to have any impact in these cases, because the distributions are made to new companies rather than directly to the individual shareholders.

Implications for those planning to retire and wind up their companies

Any shareholder director who had already been intending to retire and wind up their company should consider whether this can be done before 6 April 2016, to avoid any possible risk of the new two year rule biting, should they later change their minds and start up a similar business, or become active in a similar business run by a connected person.

Further changes likely

Note: As well as the Finance Bill 2016 clauses themselves being under consultation, a separate consultation process is also underway on wider issues, which may see further changes in this area in the near future.  For example, the conditions to obtain capital treatment on the purchase of own shares have been mentioned as possibly being tightened.


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