Written by Andy Vessey ATT, Larsen Howie's Head of Tax

HMRC warns that Targeted Anti-Avoidance Rule (TAAR) avoidance schemes will be investigated.

Finance Act 2016 introduced the ‘Distributions in a Winding Up’ legislation. This was designed to tackle ‘phoenixism’, whereby companies are serially 'wound up' - a method of ending or dissolving a business - and the shareholders receive capital distributions, which are only liable to capital gains tax at the rate of 10% where Entrepreneurs’ Relief is available.

Targeted Anti-Avoidance Rule (TAAR)

S.396B was inserted into ITTOIA 2005, Part 4, Chapter 3, and seeks to reclassify a capital distribution as one of income, i.e. a dividend subject to income tax, provided the following conditions are met:

Condition A
The shareholder’s interest in the company is at least 5%.

Condition B
The company is a ‘close’ company.

A close company is a limited company with five or fewer 'participators', or a limited company of which all the 'participators' are also directors. For most small limited companies, 'participators' will just mean shareholders.

Condition C
Within 2 years beginning with the receipt of the distribution in winding up:

a. the individual carries on a similar business either as a sole trader or in partnership;

b. the individual or a person connected with him/her has an interest of at least 5% in a company that carries on a similar business, or is connected with such a company; or

c. the individual is involved with a similar business carried on by a person connected with him/her.

Condition D
It is reasonable to suppose having regard to all the circumstances that a main purpose of the winding up is the avoidance of income tax or is part of arrangements, the main purpose of which is to avoid income tax.

This legislation would affect all contractors who carry on the practice of running a company for a few years, then closing it down and forming another but only if they received the remainder assets (in most cases this will be cash) of the dissolved company as a capital distribution. This type of arrangement has been practised by some freelancers in the past, mainly as a way of attempting to swerve IR35.

Spotlight 47

It hasn’t taken tax avoidance scheme promoters long to come up with a solution to circumvent the Distributions Legislation. However, HMRC has quickly got wise to it and has warned users and potential users of these schemes in their guidance Spotlight 47, that participation in these schemes will result in them suffering a tax investigation.

According to HMRC, scheme promoters claim that by making an artificial modification of the arrangements aimed at defeating the intention of the legislation - e.g. by selling the company to a third party rather than winding it up - it will prevent the TAAR from applying. Not surprisingly, HMRC does not accept this and takes the view that such schemes are doomed to failure because:

  • in many cases, the actual outcome is that the individual is receiving distributions in a winding up, as the individual carries on trading using a different vehicle and therefore these schemes are within the scope and purpose of the TAAR; and
  • ‘phoenixism’ arrangements that claim to involve payments to shareholders taxed as capital instead of income are caught by the TAAR or other provisions.

General Anti-Abuse Rule (GAAR)

The GAAR provides for the counteraction of tax advantages arising from arrangements that are abusive and is just another part of HMRC’s armoury available to the department to tackling tax avoidance. It does not replace or supersede TAARs or DOTAS (Disclosure of Tax Avoidance Schemes) obligations.

Where HMRC wishes to make adjustments under GAAR, they must follow detailed procedural requirements. In any court/tribunal proceedings involving GAAR, the burden of proof lies with the Revenue and not the taxpayer. If it is claimed that the ‘phoenixism’ TAAR does not apply to arrangements, then HMRC has warned that they will consider whether or not GAAR is appropriate.

Penalties

Should GAAR apply then for transactions post-14th September 2016, a 60% user penalty may be imposed.

For transactions entered into on or after 16th November 2017, any person who enabled the use of these type of schemes may be penalised as an enabler of an abusive scheme. The level of penalty will be equal to the amount of consideration they received for facilitating the arrangements. Scheme participators may also be handed a penalty for filing an inaccurate tax return, the maximum being 100% of the undeclared tax, although to make this level or penalty stick HMRC would have to demonstrate that a person indulged in serious tax evasion.

Needless to say, HMRC’s advice to taxpayers is don’t get involved with these schemes.

Already using these schemes?

HMRC is urging anyone involved with one of these schemes to voluntarily declare any distributions as dividends and pay the resultant income tax. If someone is time-barred from amending their Self-Assessment tax return, then HMRC would like them to settle with the department.

Anyone using a ‘phoenixism’ scheme and is concerned about the potential tax consequences can contact HMRC to discuss their affairs. Alternatively, Larsen Howie can help you understand your tax position and a way forward by contacting andy.vessey[email protected].