By Lynne Gowers on 18th August 2017

HMRC and the target of the phoenix

It might sound like the latest Harry Potter book, but in fact what we are talking about here is the government’s Targeted Anti-Avoidance Rule (TAAR) on winding up companies.

This rule was specifically introduced in 2016 to target “phoenixism”. This the practice whereby a limited company is wound up in order that its shareholders can receive a capital payment instead of a dividend, so reducing their tax liability. This is quickly followed by the formation of a new company, effectively “rising from ashes” of the old one, and carrying on the same trading activity.

How “phoenixing” worked

Here’s an example:

Mr Smith is an IT contractor who conducts his business through his own limited company. At the end of each year, instead of paying himself a dividend, which would be liable to Income Tax, Mr Smith winds up his company and receives the profits as a distribution in a winding up, liable to Capital Gains Tax, thus reducing his tax liability. He then immediately forms a new company and continues to ply his trade as before.

HMRC introduced TAAR legislation in 2016 to prevent this abuse.

Who could fall foul of this TAAR?

For HMRC’s company winding up TAAR to be applied, a number of conditions need to be met:

Condition A – the person receiving the distribution of funds had at least a 5% interest in the company immediately prior to the winding up.

Condition B – the company was a close company at any point in the two years ending with the start of the winding up. (A close company is defined as a company under the control of its directors or with fewer than five independent participants.)

Condition C – the individual receiving the distribution of funds continues to carry on, or be involved with, the same trade, or similar, to that of the wound up company in the next 2 years.

Condition D – it is a reasonable assumption that the main purpose of the winding up is the avoidance or reduction in Income Tax payable.

Click here for HMRC’s updated guidance on the sorts of scenarios they consider the TAAR should and should not apply to.

If caught by this TAAR

If the company winding up TAAR applies, the distribution of profits will be treated as a dividend, and subjected to dividend tax, instead of the lower 10% rate of Capital Gains Tax.

Seek professional advice

If you are considering winding up your company for commercial reasons, your accountant will be able to advise you on your risks of being caught by this anti-avoidance measure.

Free resources

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Written by Lynne Gowers
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