The current COVID-19 crisis has curtailed a lot of positive business activity such as mergers and acquisitions, but advisers are continuing to review and advise on reorganisation of their clients’ affairs to help them extract cash where possible from their businesses.
The government announced last week that amendments to certain aspects of insolvency law were intended to enable businesses, which have been adversely affected by COVID-19, to continue trading while they explore options for rescue or to restructure. While some of these measures - particularly the temporary suspension of the wrongful trading provisions for company directors - are welcome, there are some directors who will feel that a members’ voluntary liquidation (MVL) might be the least painful route to put a stop to accumulating debt and liabilities. This will be of particular relevance if the company is currently solvent with cash still held on the balance sheet. An MVL where a business has come to an end can be an efficient exit for shareholders where the distribution of assets to shareholders is taxed as capital at 10% or 20% rates.
For advisers being asked to advise clients on the tax consequences of MVLs the targeted anti-avoidance rules (TAAR) - s 396B Income Tax (Trading and Other Income Act) 2005 – are relevant. If the TAAR applies, the distribution will be taxed as income. There are four conditions which need to be met for the TAAR to apply and the key ones are Condition C and D.
Condition C
Condition C is that, at any time within the period of two years beginning with the date on which the distribution is made:
(a) the individual carries on a trade or activity which is the same as, or similar to, that carried on by the company or an effective 51% subsidiary of the company
(b) the individual is a partner in a partnership which carries on such a trade or activity,
(c) the individual, or a person connected with him or her, is a participator in a company in which he or she has at least a 5% interest and which at that time -
(i) carries on such a trade or activity, or
(ii) is connected with a company which carries on such a trade or activity, or
(d) the individual is involved with the carrying on of such a trade or activity by a person connected with the individual
Condition D
Condition D is that it is reasonable to assume, having regard to all the circumstances, that:
(a) the main purpose, or one of the main purposes, of the winding up is the avoidance or reduction of a charge to income tax, or
(b) the winding up forms part of arrangements the main purpose or one of the main purposes of which is the avoidance or reduction of a charge to income tax.
So the situation may well be that company owners responsibly liquidate companies while still solvent and rely on distributions to them being treated as capital and subject to CGT. If, after recovery from the financial pain of COVID-19, the same business is restarted within two years of the distribution to shareholders, Condition D could be in point and the result being distributions taxed as income instead of capital.
There is no advance clearance procedure for the TAAR. At the moment, HMRC have paused some compliance activity but in two years’ time HMRC may be looking at these transactions to see whether one of the main purposes for the liquidation was the avoidance of tax. To rebut a future challenge, a file of evidence should be maintained to support the decision to enter into the MVL and the actions of the directors.
Under the current climate, such a challenge seems remote given that the government are looking to support business in whatever way possible. Given that the benevolence of HMRC is unlikely to last indefinitely, documenting the reasons for the decisions will be a useful form of defence going forward.
We recognise that the conditions in the TAAR are open to interpretation. To discuss the application of the TAAR and the availability of Tax Indemnity Insurance to cover the tax charge in the event that the legislation is proven to apply, email Jeremy Leach on Jeremy.leach@markel.com or call 07818 530 056.