In the first of a two-part article, Peter Rayney highlights HMRC’s statutory weapons to deal with tax-driven ‘phoenixism’.
HMRC has always disliked tax-engineered ‘phoenix’ arrangements.
Phoenix transactions
Typically, a trading company would be liquidated, with the shareholder(s) hoping to extract its reserves at the 10% entrepreneurs’ relief capital gains tax rate. The same shareholder(s) would then carry on the same trade through a new company, with the aim of repeating the exercise some years later.
Such arrangements are frequently motivated entirely by the avoidance of income tax, as the shareholders aim to receive the company’s distributable profits as a capital distribution. This is the type of ‘planning’ that some owner-managers tend to pick up at their golf clubs or bars. It surprises me that some accountants still think this ruse works!
Hitherto, HMRC has usually countered such ‘phoenix’ mischiefs under the ‘transactions in securities’ (TiS) regime (in ITA 2007, Pt 13, Ch 1). Indeed, Finance Act 2016 now makes it clear that a capital distribution in a winding-up is itself a TiS (new ITA 2007, s 684(2)(f)).
A successful counteraction under the TiS legislation would result in the shareholder(s) being taxed on the purported liquidation distribution at significantly higher ‘dividend’ income tax rates. Given this tax risk many prudent advisers often apply for advance ITA 2007, s 701 clearances before implementing a winding-up. This would enable them to proceed with the commercially driven liquidation with the comfort that HMRC would not seek to tax the liquidation proceeds under the TiS regime.
However, it seems that a number of ‘phoenix’ arrangements were not being picked up by HMRC’s fiscal radar. In many cases, this was down to a lack of proper disclosure on the shareholders’ tax returns.
Anti-phoenix rule
Although HMRC had the TiS regime at its disposal, it clearly felt the need for a more targeted statutory weapon to deal with unacceptable phoenix arrangements. Finance Act 2006 delivered this in the shape of the ‘new’ ITTOIA 2005, s 396B, often referred to as the ‘anti-phoenix’ targeted anti-avoidance rule (TAAR). This targets liquidation distributions that are paid as part of ‘offensive’ phoenix arrangements by UK resident companies.
ITTOIA 2005, s 396B lays down four conditions, all of which must be satisfied to trigger the TAAR for the relevant shareholder. These conditions are:
- Condition A - Immediately before the company is wound-up, the individual shareholder must have held at least a 5% equity (and voting) interest in the company;
- Condition B - The distributing company must be a close company (or was a close company at some point within the two years before the winding-up);
- Condition C – Within two years from the receipt of the liquidation distribution, the recipient shareholder carries on, or is involved with, the same/similar trade or activity previously carried on by the distributing company. The required ‘involvement’ of the shareholder can be through any business format and is widely defined in ITTOIA 2005, s 396B(4) to include being in business:
• as a sole trader; or• through a partnership/LLP in which they are a partner; or• via a company in which they (or a ‘connected person’) have a 5% equity and voting interest
(cases where a connected company carries on the same/similar business are also caught); and
- Condition D – Having regard to all the circumstances, it is reasonable to assume that the main purpose, or one of the main purposes, of the liquidation or arrangements is the avoidance or reduction of income tax.
The circumstances in Condition D particularly include that Condition C is met. HMRC’s view is that Condition C is widely drawn but Condition D narrows the application to circumstances where, when considered as a whole, the arrangements appear to have a tax advantage as one of the main purposes.
Practical Tip:
All close company liquidations should carefully be examined to determine whether they are likely to be caught under the anti-phoenix TAAR.
