End of company winding up tax break

6 April 2016 changes

Certain company distributions will be treated as income, as opposed to capital, from 6 April 2016. The new measure is intended to clamp down on those who are arranging their affairs in order to take advantage of the lower capital gains tax (CGT) rates in an unacceptable way. One area where the government believes this kind of tax planning is most likely to occur is “phoenix” companies.

What’s a phoenix company?

A phoenix company is created when a company is wound up and a new company effectively rises out of the ashes to carry on the same or similar activities. In the absence of other features, a distribution made in a winding up is currently treated as capital, not income, for tax purposes. The amount received by the shareholder is therefore subject to the lower CGT rates rather than income tax (at the dividend tax rates).

Anti-avoidance measure

HMRC is concerned, however, that individuals may be winding up their companies to exploit these rules and gain a tax advantage, rather than for genuine commercial reasons. It’s therefore introducing a new anti-avoidance rule, preventing some distributions in a winding up from being taxed as capital. Clause 35 of the Finance Bill 2016 states that a distribution on winding up will be subject to income tax if the following conditions are met:

• The person receiving the distribution must have held at least a 5% interest in the company immediately before the winding up.
• The company has to be a close company.
• At any time in the two years following the winding up, the person that receives the distribution continues to be involved, directly or indirectly, in a similar trade or activity.
• The winding up forms part of arrangements designed to reduce a person’s income tax liability – this will be less likely to prove if the person no longer continues to be involved in the similar trade.

Note: Distributions will not be taxed as income to the extent that they represent capital gains base cost.

Property developer problem

To mitigate risk, it’s common practice for property developers to set up a separate company to carry out each individual property development project and then wind it up when the project is finished. On liquidation, the shareholders receive the retained profits as capital on which CGT must be paid. Unless you can successfully argue that there’s no tax motivation to these arrangements, you will need to warn your property developer clients of increased income tax bills due to the new rules. If a client wants to wind up their company with the intention of continuing to trade in a new company, or even as a sole trader or partnership, from 6 April 2016 any final distribution of profits from the company will be taxed as income at dividend rates rather than as capital.