An HMRC proposal to prevent company owners from converting income into capital has the potential to create unproductive work for HMRC and taxpayers unless it includes a clearance provision. This is the key conclusion in a response1 by the Association of Taxation Technicians (ATT).
The intended target of HMRC’s draft proposal2 is the practice of closing down a company, extracting its reserves through a winding-up and then opening a new business with a similar trade. The perceived mischief is that this enables the company’s profits to be extracted at a Capital Gains Tax (CGT) rate as low as 10 per cent instead of the considerably higher rates of income tax which apply to remuneration and dividends3.
The new anti-avoidance law would apply to distributions from a company winding-up after 5 April 2016 and as currently drafted would require taxpayers to decide for themselves whether the provisions applied in their particular circumstances.
Michael Steed, President of the ATT, said:
“We can understand why the Government wants to prevent a loss of income tax through the deliberate winding-up of companies where the same trade then miraculously springs up under the same ownership but we have two main concerns.
“First, the situations where the proposed rule could apply are very imprecisely drawn. That will create a lot of uncertainty and require taxpayers and HMRC officers to spend time considering whether the rule applies in circumstances where on any reasonable basis it will not. At its extreme, the draft proposal requires a shareholder who receives a distribution in a winding-up to consider whether the rule applies to them if for example their old company’s trade was manufacturing doors in Dorchester and (at any time in the next two years) their husband’s sisters’ spouse or civil partner is a shareholder in a company selling windows in Windermere. The chance of the rule actually applying in that situation is minimal but the draft legislation starts with the assumption that it at least could.
“Second, there is currently no proposal to include a clearance procedure that would allow taxpayers (or their agents) to check the position with HMRC before submitting their tax return. That makes the imprecision of the proposal much more worrying. The absence of a clearance procedure has the potential to produce incorrect returns with taxpayers simply not realising that the new rule does or at least might apply to them. This in turn is likely to waste HMRC’s scarce resources in protracted enquiries including some which will create lots of tasks but no tax. If there was an appropriate clearance procedure (possibly even in an automated digital form), that could reduce the risk of incorrect returns in the first place and enable HMRC to target its resources on those situations where the rule was intended to apply.
“This Association would be pleased to join in any discussions that would help make the proposal better focused and introduce a much needed clearance procedure.”
Notes for editors
1. ATT’s response to the proposal can be found here.
2. The thinking behind the proposal is in HMRC’s consultation document on Company Distributions – see here.
The wording for the draft proposal is at page 127 here.
3. Income tax rates on remuneration are 20%, 40% and 45%. Income tax rates on dividends for higher rate and additional rate taxpayers are 25% and 30.6% respectively for 2015/2016 but will increase to 32.5% and 38.1% respectively for 2016/2017 – see: https://www.gov.uk/government/publications/tax-and-tax-credit-rates-and-thresholds-for-2016-17/tax-and-tax-credit-rates-and-thresholds-for-2016-17