Following the 31 January filing deadline, we can expect to see the first ever HMRC enquiries regarding the company winding up Targeted Anti-Avoidance Rule (TAAR) start to appear.
The TAAR was introduced to prevent individuals lowering their tax liability by converting what would otherwise be a dividend into a capital payment by winding up their company. It applies to winding up distributions made on or after 6 April 2016, making the recently filed 2016/17 self-assessment returns the first to be within scope.
Although the TAAR was originally proposed to tackle the tax advantages which can arise from phoenixing (the practice of liquidating a company and then setting up a new company to carry on much the same activities), the scope of the legislation1 goes well beyond this and has the potential to apply in a much wider range of scenarios.
This article is intended to provide a short reminder of the TAAR rules and highlight some practical considerations when advising in this area. It is not meant to be comprehensive guidance, and the underlying legislation should be consulted for more information.
The TAAR rules
Under the TAAR, 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 and subject to income tax where all of the following conditions are met:
- Condition A: The individual receiving the distribution had at least a 5% interest in the company immediately before 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
- Condition C: the individual receiving the distribution continues to carry on, or be involved with, the same or similar trade or activity as that of the distributing company at any time within two years 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.
Conditions A and B should be relatively straightforward to address - and are likely to mean that most owner managed businesses and family companies are in scope. In practice, it will be the interpretation of conditions C and D which will need pondering.
Interpreting Conditions C and D
Condition C requires you to consider:
- Whether the two trades/activities are the same or similar.
- Whether the taxpayer is involved directly or indirectly in the continuing trade/activity.
These terms are not clearly defined in the legislation. However, it should be noted that involved extends beyond traditional phoenixing, and can include where the trade is carried on personally, by a connected party, or through a partnership or company.
Condition D is highly subjective, requiring the purpose behind the winding up to be considered.
HMRC’s guidance (found in the Company Taxation Manual at CTM36300 onwards) is very limited in nature, and contains only a few examples to illustrate the practical application of the TAAR. The ATT has written to HMRC asking for the guidance to be expanded (see here). However, to date, HMRC have been reluctant to provide further examples.
The guidance does however illustrate the potentially wide scope of Condition C:
- Similar may be interpreted quite broadly – HMRC state for example that the provision of gardening services is similar to the provision of landscape garden design services (even though a landscape garden designer may never so much as pick up a trowel in practice!) and that a building trade specialising in loft conversions is similar to one specialising in extensions.
- There is no need for a new activity to be set up for the TAAR to apply – a second business which already existed at the time of winding up the first business can meet Condition C.
- Becoming an employee of a similar business operated by a connected party may be sufficient for Condition C to be met.
Even where Condition C is met, it should be remembered that Condition D also needs to be met for the TAAR to apply.
HMRC view Condition D as acting to narrow the scope of the TAAR, with Condition C drawn intentionally wide. Unhelpfully, the guidance contains very few examples to illustrate when Condition D may (or may not) apply, stating instead that this is inevitably a question of judgement to be made on the basis of facts in individual cases.
The guidance does set out a list of issues to consider for Condition D, including the size of the tax advantage, nature of involvement in the continuing trade or activity, past behaviour and any special circumstances. These illustrate that applying Condition D is not clear cut, and that there is a close interaction with Condition C.
What should advisers do?
The TAAR is self-assessed and there is no clearance procedure, meaning that the onus is very much on the taxpayer and their adviser to reach a conclusion as to whether it applies to any distribution on winding up.
If an enquiry is opened into a client’s 2016/17 return where the TAAR may be in play, it will be important to gather as much evidence as possible to demonstrate the reason why it did not apply. This will most commonly be on the grounds that one or both of Condition C or Condition D were not met.
Going forwards, if it is concluded that the TAAR does not apply in a particular case, an adviser may wish to consider taking steps to protect their clients from possible penalties should HMRC disagree. For example, it may be advisable to document the reasoning behind this conclusion and gather evidence to demonstrate the commercial background to the winding up and the lack of any intention to continue in the same or similar trade or activity.
If there is real uncertainty as to whether the TAAR applies, taxpayers may want to consider making a ‘white space’ disclosure on their self-assessment return - although given the complexity of the rules it may be difficult to confine any explanation to the space available.
- s396B ITTOIA 2005 for UK companies and s404A for non-UK companies