Many entrepreneurs expecting a modest tax charge when ‘cashing out’ at the end of their company’s life cycle may be in for a shock.
Currently, with the benefit of CGT Entrepreneurs’ Relief, shareholders initiating a solvent Members Voluntary Liquidation (‘MVL’) of their company could be expecting the tax rate to be as low as 10%.
However, following a recent announcement by HMRC, proposed changes mean it will be a lot more difficult to secure a 10% tax rate and instead an increased rate of up to 38.1% may apply. This will be particularly relevant for so called ‘phoenixing’ where a similar business is set up soon after a liquidation.
For those affected, urgent action may be required to ensure MVLs are commenced and distributions of capital are made before 6 April 2016 when the new rules come into effect.
Who may be affected?
Individuals receiving a distribution on the winding-up of a company.
How are things changing?
Currently, the general rule is that any distribution in a winding-up is charged to Capital Gains Tax (‘CGT’) in the hands of an individual. The rate of tax is a maximum of 28%, but may be as low as 10% (if Entrepreneurs’ Relief is available).
Under the new proposals, distributions will, in some common circumstances, be chargeable instead to Income Tax, at rates ranging up to 38.1%.
From when will the changes be effective?
The rules will apply to distributions made after 5 April 2016. Whether the liquidation commences before or after that date will be irrelevant.
Which type of distributions may be caught in the future?
The wide ranging Transactions in Securities (‘TIS’) legislation may be applied to most distributions. In addition new targeted rules will apply if three conditions are all met. Broadly the conditions are as follows.
Condition A: The company is a “close company” (or has been such a company within the previous two years). This will include most privately-owned companies.
Condition B: Within two years after the date of the distribution, the individual receiving the distribution (or someone connected with him or her) is involved in carrying on any trade or other activity previously carried on by the company (or any similar trade or activity); this could for example be as sole trader or via a partnership LLP or new company.
Condition C: It is reasonable in all the circumstances to assume that one of the main purposes of the liquidation (or arrangements of which the liquidation forms part) is the avoidance of Income Tax. For this purpose the fact that Condition B is met is regarded as a relevant circumstance.
What exclusions are there?
There is no charge to Income Tax to the extent that the amount distributed does not exceed the amount originally subscribed for the shares, subject to certain limitations; or is itself a shareholding in a subsidiary company.
In either case there may be a charge to CGT, as under current rules.
Many shareholders will face significantly increased tax charges if these changes become law as currently drafted. Therefore, it is vital that action is taken well before 6 April 2016.
Please contact the Insolvency and Recovery team if you wish to discuss this matter further.