The good old days
Up until 5 April 2016, if an individual received a distribution from a company in a winding up this would be taxed as a capital gain and they could claim appropriate reliefs, including entrepreneurs’ relief, if appropriate.
Finance Act 2016 introduced measures, including a targeted anti-avoidance rule (TAAR), to prevent what is known as ‘phoenixism’. This is where an individual, or individuals, operate a business through a company which then ceases to trade and is liquidated, but the individuals continue to operate a similar business through another company. The purpose of many arrangements of this nature was, in HMRC’s opinion, to extract funds as a capital distribution, which would otherwise be taxed at favourable capital gains tax rates, rather than as an income distribution liable to significantly higher income tax rates.
With effect from 6 April 2016, such ‘phoenixism’, which involves a similar business being carried on within two years of the cessation of the previous business, has been open to challenge by HMRC and the liquidation proceeds could be liable to income tax rather than capital gains tax.
All change again
In a technical update issued by HMRC in February 2019, and discussed at a meeting with professional bodies in May 2019, it was announced that artificial modifications of standard ‘phoenix’ arrangements to liquidate a company and start or continue a similar business would not prevent challenges from HMRC. The example of an artificial modification of phoenix arrangements provided by HMRC is where the company to be liquidated, having ceased its business activities and sold its assets, is instead sold to a third party. HMRC considers that selling shares in a company as an alternative to liquidation would be unlikely to reduce any uncertainties around whether the TAAR, or otherwise the GAAR (general anti-abuse rule), would apply to counteract any potential tax advantage, and that it will challenge situations where the purpose of the legislation appears to be deliberately circumvented by artificial means.
The way forward
It is too early to say how HMRC will operate this relatively new legislation. However, it is clear that if you liquidate a company and then commence or continue similar operations via another business within a two year period, you will be open to challenge from HMRC, which could result in you suffering income tax rather than capital gains tax on the liquidation.
Professional advice should therefore be taken in all such situations.
For more information please get in touch with Nick Parker.