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Markel Tax

21 Jan 2019

Phoenix Knights: Tax Indemnity Insurance ensures reorganisation doesn’t get stuck in TAAR

Whilst it might be a bit of a stretch to infer that like gallant Knights, the tax and insurance specialists of Markel Tax rode on their white chargers to the rescue of a company reorganisation where “phoenixism” was the issue and the Government’s Targeted Anti Avoidance Rule was likely to be invoked, it is fair to argue that we were able to provide the necessary degree of comfort to allow the transaction to go ahead.
 
As in a number of similar cases we have seen recently, a business was subject to a Members Voluntary Liquidation which involved cash and property assets being distributed to the shareholders.  The disposal proceeds were treated as capital gains in the hands of the shareholders, upon which Entrepreneurs Relief (ER) had been claimed.  ER meant the gains were taxed at 10%.  
 
However, the 2016 Finance Act Introduced Sec 396B (Targeted Anti Avoidance legislation), which, if HMRC were successful in arguing applied to the disposal, would tax the proceeds at an additional 28.1%, and result in a further £2 million tax being due.  
 
A quote was sought for a policy to cover the potential tax and interest, as well as the fees to contest any HMRC enquiry.  Based on an estimate of interest and fees to contest an enquiry reaching £100,000, an overall limit of almost £3 million was sought.  
 
As readers will know, the purpose of Sec 396B ITTTOIA 2005 is to counter phoenixism; i.e. starting a new business shortly after winding up a previous one.  The practical effect of Sec 396B is to tax the proceeds from a liquidation as income rather than capital.  There are four conditions which need to apply before Sec396B is in point and these are summarised below:
 
Condition A determines that, immediately before the winding up, the individual has at least a 5% interest in the company. 
 
Condition B is that the company is a close company when it is wound up, or was a close company at any time in the period of two years ending with the start of the winding up. 
 
Condition C requires that, at any time within the period of two years beginning with the date on which the distribution is made, the individual carries on a trade or activity which is the same as, or similar to, that carried on by the company. 
 
Condition D states:
“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.”
 
In this case it was accepted that Conditions A, B and C applied, but the question was whether condition D applied.
 
The reason why the client considered the MVL to be appropriate was that the shareholders wished to realise their interests in the company to release funds for other commercial activities not connected with the original company or indeed with each other. The fact was, the original entity had reached the end of its natural life and liquidation was the most logical course.
 
Even though the new ventures would be in a similar sector – because of the clients knowledge and expertise – it was felt that they were sufficiently diverse in their nature and did not share identical characteristics; i.e. a different customer segment and largely different suppliers. Moreover, the amount of work involved in the new ventures was such that it was going to be necessary to take on new staff specifically to work on the business of the jointly-owned companies. 
 
There were also financing considerations: in order to execute the new business, it would be necessary to create a separate special purpose vehicle ("SPV") for each deal. There were two reasons for doing so: firstly, the desire to invest in larger projects and the need to isolate individual risks; secondly, banks are increasingly demanding that loans are secured by a debenture over all the assets of the borrowing company. 
 
Therefore, where different banks are involved for different projects, such whole-company debentures can only be offered  by creating SPVs for each project. Even where the same bank is used for more than one project a whole-company debenture requires (from the borrower's perspective) the use of SPVs in order to limit the bank's security to the assets involved in the particular project being financed and to avoid exposing to risk all the value accumulated from previous transactions.
 
Counsels opinion was taken and concluded that the balance of probability on the facts presented was that Sec396B did not apply and that there was no doubt that PC had a defensible filing that there appeared to be mainly commercial reasons for the liquidation.   
 
However, due to the correspondence which had previously taken place with HMRC, the risk assessment concluded that the claim for Entrepreneur’s Relief had a high probability of being challenged – even if there was an extremely good chance of withstanding that challenge – and had a practical impact for arranging cover for the defence costs.  It was clear that there would need to be an appropriate level of excess for contest fees – the basis of any tax indemnity policy being that the matter must be robustly contested if challenged by HMRC.
 
Whilst on this occasion it was possible to offer cover and this type of transaction is one which is often considered for tax indemnity insurance, it should be noted that there is actually a very wide range of matters where tax indemnity insurance is appropriate.
 
Our view is that whenever there is uncertainty in a sizeable tax transaction, there is potentially scope for a tax indemnity insurance policy to apply.  Nevertheless, where practices are involved in M&A work, we know that they want to be the first adviser to raise the insurance – particularly when tax is the stumbling block to the transaction!
 
For further information, please contact Markel Tax on 0345 223 2727 and ask for Jeremy Leach, Steve Faulkner or Paul Mason.
Tagged TAAR Tax Indemnity
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