Tim Palmer, Arram Berlyn Gardner’s tax consultant and highly respected tax lecturer, writes in this blog post about his recent experiences with the CGT Targeted Anti-Avoidance Rule (TAAR).
After I have presented a tax webinar, delegates often email me with their recent tax experiences and I have had several accountants contact me recently, stating that they have had clients attacked by HMRC under the relatively new CGT TAAR anti-avoidance legislation.
In very general terms, this HMRC attack will arise when the owner of a close company liquidates it, and then starts up the same trade again within two years. For the legislation to apply, HMRC have also got to prove that he liquidated his company to avoid income tax.
He will have extracted the funds as capital distributions and paid tax at only 10%, thanks to the Business Asset Disposal relief (BADR), previously known as Entrepreneurs’ Relief.
The impact (if HMRC succeed with their attack) is that HMRC will go back to the capital distributions in the liquidation, and re-tax them at the higher income tax distribution rates.
It should be noted that the Budget has increased the rates of income tax applicable to dividend income. At present, the ordinary rate, upper rate and additional rate are 7.5%, 32.5% and 38.1% respectively. This measure will increase each rate by 1.25% to 8.75%, 33.75% and 39.35% from April 2022. This will have a big impact if HMRC apply the TAAR anti-avoidance legislation from 6th April 2022 onwards!
Can I now go back to basics, and look at the effects of this anti-avoidance legislation in more detail.
It was introduced by the Finance Act 2016, with little accompanying guidance, the TAAR legislation is found at Income Tax (Trading and Other Income) 2005 Section 396B (for UK companies) and 404A (for non-UK companies)
Its Objective… To stamp out the practice of ‘phoenixism’ – the act of starting up a new business soon after winding up a previous one, allowing a shareholder to receive accumulated profits in capital form and, by claiming BADR, paying tax at a rate of just 10%, rather than the dividend rates of up to 38.1% that would have otherwise applied.
The rules… A distribution in a winding up made to an individual on or after 6 April 2016 will be treated as if it were a distribution, with an effective rate of tax of up to 38.1%, if ….
All four conditions (A – D) are met:
- Condition A: The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up
- Condition B: the company was a close company (or, for non-UK resident companies, would have been a close company if it was a UK resident company) at any point in the two years ending with the start of the winding up
- Condition C: the individual receiving the distribution continues to carry on, or be involved with, the same trade or a trade similar to that of the wound up company at any time within two years from the date of the distribution
Accordingly, there is a danger of the TAAR applying if the shareholder liquidates his company and then starts to carry on the same or a similar trade, within two years from the date of the last capital distribution via…
- A sole trader
- A partnership
- A company
- An LLP
- An employee of a connected person
- Condition D: it is reasonable to assume that the main purpose, or one of the main purposes of the winding up is the avoidance or reduction of a charge to Income Tax.
For HMRC to successfully apply the TAAR, they must prove that all four conditions (A – D) have been met.
The impact of the TAAR
The impact (if HMRC succeed with the TAAR assertion) is that HMRC will go back to the capital distributions in the liquidation and re-tax them as income dividends at the higher income tax rates.
Was the main purpose of the winding up the avoidance or the reduction of a charge to income tax?
Case study 1
The architect who retired, aged 64, liquidated his company, and got bored. He then went to work for his brother’s architect’s firm, as a senior employee. HMRC attacked this under the TAAR. The accountant defended his client saying that he liquidated his company to retire, not to avoid income tax! This dispute is apparently ongoing.
Case study 2
Fred’s company, Fred Ltd, is caught to IR35 under the new private sector rules, from 6th April 2021, regarding its engagement with the Lewis Group. They came to an agreement whereby he joined the Lewis Group as an actual employee from 6th April 2021.
Accordingly, he liquidated his company because he no longer needed it.
Caught by TAAR?… No!
- He is not going to be an employee of a connected person (condition C not met), and
- He did not liquidate to avoid income tax (condition D not met).
Clients need to be careful about liquidating their company and starting the same trade up again within the next 2 years! And when the income tax rates on dividends go up next year, this anti-avoidance legislation could be expensive.
If you wish to speak to Tim or a member of our tax team to discuss how we might help you and or your client you can contact us on 020 7330 0000.
Tim Palmer – email@example.com