Phoenix from the flames
In 2016, new rules were introduced to stop a type of “phoenixism”. Not the old sort that really got HMRC’s goat where someone would pay all their debtors but HMRC and then brazenly put their company down only to start trading again (often with a slightly different name). The 2016 rules are aimed at situations where a person would have a profitable company and instead of paying themselves a dividend, they would liquidate the company with the resulting pay-out being treated as a capital gain rather than as income, then start up a new company and carry on their old trade as before.
The new rules apply if four conditions are met. The first two are semi-obvious: the company must be close (normally owned by 5 or less people) and the person receiving the pay-out must own at least 5% of it. These conditions mean that it is in effect owner managed businesses that are affected, which is fair enough, given it is only really owner managed businesses that would have used this technique!
The third condition defines the phoenixism, in that it applies where a person carries on a similar business within two years of the winding up. For instance, if I had a “side hustle” (as I believe it is called by hipsters and tech savvy people) of selling gizmos through my limited company, wound that company up and started another one within two years, or indeed carried on the trade of selling gizmos personally within two years, I would be within the third condition. If, however, I started a business consultancy practice that would not be within the TAAR.
The final condition is the purpose test and will apply where it is reasonable to assume that the, or one of the main, purposes of the winding up is to avoid a charge to income tax.
These rules clearly hit the sort of abuse that HMRC is worried about; however, in a reversal of usual anti-avoidance legislation where HMRC tax by legislation and relieve by guidance (as with the Capital Loss TAAR), they now appear to be trying to tax by guidance (and the case of Gaines-Cooper made it clear that HMRC guidance does not replace legislation)!
To wind up or not to wind up
As this is a TAAR and whether it will apply or not is open to some uncertainty. Is your new business similar enough to your old one to trigger the third condition, or is it reasonable to assume (a wonderfully vague concept that is all the rage in anti-avoidance legislation these days) that you carried out the winding up to avoid income tax?
You can achieve certainty by selling your old company. This could be to a competitor, it could be part of a merger, or it could be to someone who has a trade in buying companies with cash reserves. In this latter case, the person buying the company now faces the dilemma you did of what to do with the company. But then again, the price paid for your shares will no doubt reflect this as the purchaser will want to make a profit and may face a different tax treatment to you. This means you will receive less than from a trade sale or if you wound the company up.
However, the decision to sell has been made and there is not a winding up in sight, or is there?
Shine a spotlight darkly
The winding up TAAR is clearly and unequivocally aimed at a certain mischief. The legislation is headed “distributions in a winding up” and HMRC’s guidance is in a chapter entitled “Company winding up TAAR”. The pre-requisite for the rules to apply is that there has to be a winding up.
However, HMRC issued Spotlight 47 at the beginning of February 2019 to “warn” taxpayers about an abusive scheme to circumvent the TAAR and if they used this “scheme” they (and their advisers) could face penalties under the General Anti-Abuse Rule. Spotlights are a series of HMRC articles that set out what they believe to be avoidance schemes to help taxpayers “avoid” using them and all the hassle that goes with trying to artificially lower the amount of tax they pay.
The abusive scheme HMRC are concerned about is the one mentioned above – the sale of the company to a third party. I say abusive, as HMRC are threatening the use of the GAAR to stop it, and the GAAR is an anti-abuse rule, not an anti-avoidance rule.
The Spotlight says:
“They [advisers] claim that by making an artificial modification of the arrangements aimed at defeating the intention of the legislation (by selling the company to a third party rather than winding it up, for example) the TAAR will not apply.”
However, what sort of third party do they mean? If I sold my company to a competitor is that an artificial modification of the arrangements? Should I be forced to wind the company up? Perhaps HMRC mean a certain type of third party? What about the situation where I’ve sold to a company that has a trade in buying companies with cash reserves? My motive is to obtain certainty of the tax treatment and to achieve a quick sale, as this will be quicker (and possibly cheaper) than winding the company up. Plus, and as mentioned above, I will, no doubt, have received less from this third party who now faces the dilemma I originally did. There are no contrived circumstances and no artificial steps have been inserted; it is not a case of I will sell unless the FTSE 100 doesn’t fall by over 5000 points in a day (well, perhaps not as blatant a non-gamble gamble as that).
I am, therefore, in a bit of a strange situation. I am undertaking a transaction that is being carried out for commercial reasons, is actually simpler than the one HMRC is worried about, does not contain any of the steps covered by the TAAR, yet somehow, I am carrying out an artificial and contrived attempt to circumvent the TAAR, which is not aimed at the transaction I am undertaking.
Interestingly, when I was undergoing my technical training with HMRC, much was made of several judgments where the principle to take away was “we must look at the transaction that took place and not the one that we wished had taken place”. If HMRC is going to push this Spotlight they will have to re-write that part of their training courses (and ignore judicial precedent).
Do as I say or else!
However, this could just be a heavy handed attempt to force taxpayers to do what HMRC would like. I simply cannot see how a genuine third party sale of a company can be within the ambit of a TAAR aimed at a different transaction, let alone how undertaking the sale cannot be “reasonably regarded as a reasonable course of action in relation to the relevant tax provisions” which is the test that must be failed for the GAAR to apply.
But, and here I presume is the point of the Spotlight, will anyone want to take the risk? Despite my reassurances that the Spotlight is a scare tactic, will they risk facing 60% penalties if the GAAR is successfully invoked? These, plus 38.1% tax if they are additional rate taxpayers, oh and interest, will mean that they are giving well over half the proceeds to the Government!
Further, will I put Milestone’s money where my mouth is, as a potential enabler of an “abusive” scheme and recommend to a client that they sell their company to a third party knowing that if the GAAR is invoked and its use upheld, any fee charged will be become the amount of the penalty?
I do, therefore, have to take my hat off to HMRC. They have over-reached themselves with Spotlight 47, indeed it could be said to be an abuse, but, with the current climate surrounding even a whiff of tax avoidance, they will, I believe, successfully stop a number of people from entering into genuine commercial arrangements.
Andrew Parkes can be contacted at email@example.com. This article originally appeared on the Milestone International Tax Partners website and has been reproduced with permission.