For years businesses which take on numerous projects at once often have them spread across a number of limited companies. With main purpose for this being to ring fence risk and secure the main business assets from any ‘bad’ projects.
However, a secondary advantage comes with setting up limited companies in this way. When the project is complete the company is liquidated and the profits extracted to shareholders. Liquidation proceeds are always taxed as a capital distribution and therefore shareholders usually benefit from entrepreneurs relief paying tax at just 10 per cent.
However, some businesses have been using this method with little or no commercial rationale at all, with their main purpose being to avoid the higher income tax rates. HMRC calls these businesses tax-engineered ‘phoenix’ arrangements. In order to combat these HMRC has introduced an anti-phoenix targeted anti-avoidance rule (TAAR). In order to trigger this, all of the following four conditions must be met:
- Before the company is wound up, shareholders must hold at least five per cent equity and voting interest
- The distributing company must be a close company or was close at some point within the two years before winding up
- Within two years from receiving the liquidation distribution and all profits associated, the recipient shareholder carries on or is involved with the same/similar trade
- It is reasonable to assume that the main purpose of liquidation is to avoid or reduce income tax
It’s still unclear how HMRC will test and police the new rules so each case will need assessing on its own merits. What we do know though is that all close company liquidations should be carefully examined to determine whether the main purpose is tax avoidance.
For more help and advice and to see if your company activities are likely to fall under the anti-phoenix TAAR, contact David Herd at Champion Accountants via email David.Herd@championgroup.co.uk or call 0161 703 2500.