Taxpayers completing Self-Assessment tax returns need to consider the impact of new rules if they have received a distribution on winding up their company on or after 6 April 2016 and continue to be involved in similar activities, warns the Association of Taxation Technicians (ATT).
New legislation prevents individuals lowering their tax liability by converting what might otherwise be received as a dividend into a capital payment by winding up their company.1
The new rules apply, broadly, where an individual who winds up their company continues to carry on, or be involved with, the same or similar trade at some point in the next two years and the main purpose, or one of the main purposes, is to reduce their income tax bill.2 Where this is the case any distribution on winding up will be subject to income tax, and not the lower rates of capital gains tax which normally apply.
These new rules were originally proposed to tackle tax advantages arising from phoenixing, the practice of liquidating a company and then setting up a new company to carry on much the same activities. However, the scope of the legislation goes beyond this and has the potential to apply in a much wider range of situations.
Tax returns for the tax year ended 5 April 2017 are the first when the new rules can apply. The ATT is urging potentially affected taxpayers and their agents to consider providing additional detail in the white space of the self-assessment return as this may provide some protection from penalties for errors in returns.3 This extra information could include, for example, information on the background to the winding up and why they believe the rules do not apply.
Yvette Nunn, Co-chair of ATT’s Technical Steering Group, said:
“As these new rules are self-assessed, taxpayers have to decide whether they apply. They must therefore be considered in any situation where a taxpayer has wound up their company since 6 April 2016 and continues to be involved in similar activities.
“Deciding whether the rules apply is complicated by the subjective nature of the conditions, the lack of any clearance facility and the limited practical examples in HMRC’s guidance.4
“It is unclear whether if a taxpayer genuinely believes that they do not apply, but HMRC concludes they do, penalties will be imposed.
“We have written to HMRC asking for further guidance on the application of the rules, including how HMRC will apply penalties if they consider an error has been made in a tax return.5 If there is any doubt as to whether these rules may apply, taxpayers and their agents should consider providing additional detail in the white space of the self-assessment return as this may provide some protection from penalties.”
Notes for editors
1. When a company pays a dividend to its shareholders, the distribution is normally subject to income tax at the rates applicable to dividend income (for 2016/17 these were 7.5 per cent, 32.5 per cent and 38.1 per cent depending on the individual’s level of income). By contrast, if a shareholder receives a distribution when their company is wound up, this is normally subject to capital gains tax which is generally payable at a lower rate (as low as 10 per cent if certain reliefs apply)
2. Under the new 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 subject to income tax where certain conditions are met. For the rule to apply, all of the following conditions must be met:
Condition A: The individual receiving the distribution had at least a five per cent interest in the company immediately before the winding up
Condition B: the company was a close company (broadly a company owned by its directors, or five or fewer individuals) 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
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.
3. Under Schedule 24 of Finance Act 2007, where a taxpayer submits a return or other document to HMRC which includes an inaccuracy that leads to an understatement of tax they are liable for a penalty. The amount of any such penalty is based on the taxpayer’s behaviour, including whether they have disclosed the position to HMRC. There will generally be no penalty if the taxpayer has taken reasonable care, which can include drawing HMRC’s attention to any uncertainty regarding the tax treatment of a transaction or other event.
4. HMRC’s guidance can be found in their Corporation Tax Manual at section CTM26205 onwards.
5. The ATT’s letter can be found here.