Happy New Year from HMRC?
14th December 2015 by Fiona Hotston Moore
Last week, whilst most business owners and their tax advisers were busy with their Christmas office parties, writing cards and attending carol services, HMRC slipped out draft tax legislation and a consultation document on changes which could have a significant impact on a number of individuals trading as limited companies. The proposed legislation will come into force 6 April 2016 and could impact business owners such that they may wish to seek advice early in 2016.
The draft legislation has been introduced following the changes to the taxation of dividends which were announced in the Autumn Statement and will see, from April 2016, the tax rates on dividends increase so that higher rate tax payers will pay at 32.5% and additional rate tax payers at 38.1%. However, if a shareholder receives a return as capital that receipt is generally subject to capital gains tax, which is generally at 28% but can be as low as 10%, and the government is concerned that the dividend tax changes will encourage greater use of tax planning by use of capital distributions.
Therefore, HMRC is proposing to tighten up the existing ‘Transactions in Securities’ rules to include a connected parties rule and also to bring them in line with Self Assessment such that if a tax payer is ‘caught out’ significant interest and sizeable penalties will be levied in addition to the extra tax. Additionally, there will be a new Targeted Anti Avoidance Rule (TAAR) that will apply to certain capital distribution to combat a practice known as "Phoenixing".
The TAAR will treat certain distributions in ‘winding-up’ situations as liable for income tax if an individual shareholder:
- receives a distribution on shares in a ‘winding-up’ and, within two years, continues to be involved in a similar trade or activity (including as a sole trader, partnership or company); and
- one of the main purposes was to obtain a tax advantage.
The legislation is currently draft but consultation is only open until 9 February and, as the new measures will be in force 6 April, it is important that we look carefully at the implications.
At this stage we cannot be certain what transactions will be caught but those considering the following should seek advice and allow time to get advance clearance for transactions in securities:
- Distributions on winding up.
Historically shareholders might retain cash reserves in a company in excess of commercial needs and so receive these monies taxed at capital rates when the company is wound up. This is known as "Moneyboxing' and was always open to challenge but it will now be far easier for HMRC to identify and the penalties for perceived tax avoidance are far higher.
The changes also impact "Phoenixes" where the company enters a Members Voluntary Arrangement, gets a distribution at capital tax rates and then the shareholders start a new company.
Finally, special purpose companies are sometimes used where activities or projects are split across several companies and at the end of a project a company is wound up to extract the profits as a chargeable gain rather than as income. For example property projects.
- Disposals of shares to third parties could be caught if the company sold is perceived to contain more cash than is needed to return such cash into capital. Albeit sellers would not necessarily pay £ for £ for surplus cash. Furthermore, a seller who sets up again within two years might also be caught by the ‘Phoenixing’ rules.
- Purchases of own shares.
The rules will be tightened further so that if the seller retains sufficient interest to block a special resolution they will lose the capital treatment of proceeds. Historically sellers may have kept an interest either because the buyer couldn't finance an acquisition of 100% or to ensure the seller retained an interest in the success of the business.
- Repayment of share capital following a reorganisation.
Previously a reorganisation involving a new holding company could potentially convert retained profits into capital which was repaid at capital gains rates.
I suspect Insolvency Practitioners and Corporate Finance advisers may see a flurry of transactions in the New Year and, whilst tax should not drive commercial decision making, it is prudent to ensure that the commercial outcome won’t be hit by an unexpected tax bill in the future.
Finally, this is not the end as the HMRC consultation asks for views on further ideas to prevent conversion of income to capital for tax gain. Such further changes will not be introduced in April but it’s clear we are moving towards a convergence of income and capital gains tax rates....which for higher rate taxpayers is going only in one direction as the government struggles to address the budget deficit by 2019.
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