Many accountants have reported instances of clients facing HMRC enquiries under the relatively new CGT Targeted Anti-Avoidance Rule (TAAR).
This HMRC enquiry 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 must prove that they liquidated the company to avoid income tax. This means they 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 enquiry) 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 large impact if HMRC apply the TAAR anti-avoidance legislation from 6th April 2022 onwards.
What are the effects of the CGT Targeted Anti-Avoidance Rule?
It was introduced by the Finance Act 2016, with little accompanying guidance, and is found at Income Tax (Trading and Other Income) 2005 Section 396B (for UK companies) and 404A (for non-UK companies).
The objective?
To stamp out the practice 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 6th April 2016 will be treated as if it were a distribution, with an effective rate of tax of up to 38.1%, given all four of the following conditions are met:
- The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up
- 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
- 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
- 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
Case study
Was the main purpose of the winding up the avoidance or the reduction of a charge to income tax?
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, because:
- 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)
What next?
Clients need to be careful about liquidating their company and starting the same trade up again within 2 years, and when the income tax rates on dividends go up next year, this anti-avoidance legislation could be expensive. Please do not hesitate to contact us for assistance or guidance on any of the matters discussed.
