Taxation of company distributions & the new targeted anti-avoidance rule

Taxation of company distributions & the new targeted anti-avoidance rule

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Draft legislation for inclusion in Finance Bill 2016 was published by HMRC following December’s Autumn Statement to amend the existing anti-avoidance provisions for “transactions in securities” (“TiS”) and, to introduce a  new targeted anti-avoidance rule (“TAAR”) for certain distributions made on the winding-up of a company. The amended legislation and the new TAAR are designed to counter what the government has described as, “examples of active tax planning in areas it believes lead to unfair outcomes”, essentially, by the conversion of income to capital in the hands of the shareholder.

 

The Issue

HMRC have long been concerned that shareholders of close companies have used members’ voluntary liquidations (“MVLs”) as a means of distributing reserves in capital form (which would otherwise be payable as income in the form of dividends). For example, property developers will often carry-out a single development project through a  special purpose company; the company would  incur 20% corporation tax on the development profit (so £100 of profit would be reduced to £80 in the company post tax) and then the shareholder would suffer 10% tax (subject to a claim for Entrepreneurs’ Relief)  on distribution of the post- tax profits of £80 on a winding-up of the company, receiving a net amount of £72 ( £80 less £8 capital gains tax). In this way, the property developer would suffer an overall “effective tax rate” of 28% on the development profit compared with an effective tax rate of up to 44.5% (for an additional rate taxpayer) on the extraction of post-tax profits by way of dividend.

The New TAAR

A new rule will be introduced for distributions from a winding-up which are made after 5 April 2016. This will have the effect of deeming a distribution to be taxable as income rather than capital where certain conditions are met. In broad terms, the rule will apply if the recipient shareholder “continues to be involved in a similar trade or activity” (whether personally or through participation in a company) within two years of the distribution and, it is “reasonable to assume” that the main purpose (or one of the main purposes) of the winding-up is to obtain a tax advantage.

What can shareholders do now?

In circumstances where shareholders are already considering whether to wind-up their company, perhaps as part of their retirement or succession plans, they should now be considering whether it would be possible to do that before 6 April. After the 5 April, the effective rate of tax on a distribution made in a winding-up could increase by as much as 22.5% (from 28% to 50.5% for an additional rate taxpayer).

Changes to the TiS anti-avoidance provisions

There are several changes to the TiS provisions in the draft legislation, but it is likely to be the change to the tax treatment of capital reductions that is the most significant for shareholders in private companies. The change will put a stop to the practice where shareholders, by means of a share for share exchange, create significant capital in a new group holding company (at no additional cost to the shareholders) and, subsequently, reduce surplus capital in the company by means of a capital repayment to the shareholders (which, subject to a claim for ER, can reduce the tax payable by a shareholder to 10%).

After 5 April, a repayment of share capital will be within the definition of what is a “transaction in securities” and, therefore, will fall clearly within the scope of HMRC’s power to counter-act the transaction as if it was an income distribution to the shareholders subject to tax at the dividend rates of up to 38.1% for additional rate taxpayers.

Although there are no changes in the draft legislation to the tax treatment applying on a “purchase of own shares” , it should be noted that the Consultative document issued by HMRC with the draft legislation includes the statement that the government “would like to explore whether the conditions that allow capital treatment are set at the right level”. We will keep a watching brief of and provide an update on any significant future developments on this important part of the UK’s tax code as the consultation process progresses.

Please feel free to contact a member of the team if you or any of your clients are potentially affected by, either, the new TAAR or the amended TiS provisions.

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