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Markel Tax

11 May 2020

Targeted anti-avoidance and re-starting the business after liquidation

An unfortunate consequence of the current Covid-19 pandemic is the effect on the economy. Many businesses are struggling and their owners may feel that, as they move out of lockdown, now is the time to cease trading and extract what value they have in their businesses with a view to waiting for better days ahead before starting up again in business.

One option for company owners is to cease trading and liquidate the company via a members’ voluntary liquidation (‘MVL’). After collecting debts and paying off existing creditors, the remaining funds within the company can be distributed to the shareholders as capital, giving rise to a capital gain. Where the shares qualify for business asset disposal relief (previously entrepreneurs’ relief) the tax payable will only be at 10% on gains up to £1m, thereafter 20%.

Before a members’ voluntary liquidation is undertaken, the targeted anti-avoidance rules (‘TAAR’) in s 396B ITTOIA 2005 should be considered. These provisions are of particular importance for those who continue to carry on a similar activity maybe via a separate entity or those that have plans to resurrect the current business within the following two years. Where the TAAR applies, HMRC will seek to tax any liquidation distribution as an income distribution. Instead of paying capital gains tax at 10%/20% there could be income tax at 38.1%!

The TAAR applies where all conditions A to D are met.

Condition A – that immediately before the distribution, the individual has at least a 5% interest in the company;

Condition B – that the company is a close company when wound up or was close in the previous two years;

Condition C – 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 or an effective 51% subsidiary of the company;

The individual is a partner in a partnership which carries on such a trade or activity;

The individual, or a person connected with him or her, is a participator in a company in which he or she has at least 5% interest and which at that time

Carries on such a trade or activity, or

Is connected with a company which carries on such a trade or activity, or

The individual is involved with the carrying on of such a trade or activity by a person connected with the individual.

Condition D – that it is reasonable to assume having regard to all the circumstances, that the main purpose of the winding up of the company is the avoidance or reduction of a charge to income tax or the winding up of the company itself is part of a tax avoidance arrangement aimed at reducing income tax.

The key provisions are conditions C and D. In the first instance, if HMRC cannot prove that condition C applies there cannot be an income tax exposure. Therefore, if the business owner after liquidation has no intention of working and retires then condition C will not apply. Conversely, the business owner who after one year following liquidation contacts some of his old clients and starts in business perhaps in a small scale way as a sole trader, would be caught by condition C.

It is possible that the individual continues to run a similar business already, which historically was operated side by side with the liquidated company. That being the case, condition C is likely to apply.

There is no statutory definition of what is meant by ‘similar activity’. HMRC have provided some guidance in their Company Tax Manuals . However, the examples given leave little doubt that condition C would apply and there will be many cases where what may be deemed a similar activity is debatable. Some cases will no doubt end up being decided in the courts but, at the present time, judgements based on the available guidance would have to be applied on a case by case basis.

Condition D provides an opportunity to fall outside the TAAR. If it can be shown that the main reason for liquidating the company was not to avoid or reduce tax but it was undertaken for commercial reasons, then condition D would not apply. A typical example would be where an individual has genuinely retired or perhaps accepted an offer to become an employee removing the need to retain the company. Again, however, whether condition D applies or not is not always conclusive.

Example

An individual has been the sole shareholder of their property development company and also has a 5% interest in a third party company undertaking similar activity. The client does not want to continue given the current economic climate and believes now is the time to wind down and move to retirement. Having sold the latest development, the clients decides to cease to trade and liquidate their own company.  They will continue to hold the minority interest in the third party company albeit for a short period before retiring completely.

In this case, as the individual continues as a shareholder within the third party business, condition C will apply. However, it is arguable whether condition D applies given the client’s wishes to wind down and move towards retirement. As a minority shareholder in the third-party company the individual has no control over that business. Nevertheless, the client has an exit planned but, in the meantime, has been able to take the first step towards retiring by liquidating his own company which is no longer needed. This conclusion seems to fall into line with example 2 of HMRC’s guidance.

 Example 2

Mrs F is a landscape garden designer and runs her business through a company. Mrs F decides she would like to retire, and so winds up the company. In order to supplement her pension, and because she enjoys it, Mrs F continues to provide routine gardening services to a small group of clients in her local village as a sole-trader.

It is unlikely that Mrs F is carrying on “the same trade” after the winding up as that carried on by the company. However, the provision of gardening services is “similar to” the provision of landscape gardening, and so Condition C is met. (But that does not mean that ITTOIA05/S396B/404A will apply to the distribution, because all the conditions must be met, and it is not likely on these facts that Condition D – the purpose test – will be satisfied.)

Clients who are considering liquidating their companies in such situations need to think carefully about the application of these provisions. Unfortunately, there is no pre-clearance in respect of the TAAR but it is still possible to obtain a pre-clearance for the liquidation itself under the transactions in securities provisions which may provide some comfort. In the absence of tax case law the interpretation of these rules, in particular condition C and D, can be somewhat grey and inconclusive, in which case the use of tax indemnity insurance to protect against an unfavourable outcome may be attractive.

For more information on the TAAR, possible tax clearances please call Markel Tax on 0333 920 5708 and speak to Martin Mann. For advice on tax indemnity insurance ask to speak with Jeremy Leach.

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Tagged Specialist Tax Consultancy Employer solutions Specialist Tax Consultancy Employer solutions COVID-19
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11 May 2020

Capital Allowances on property purchases