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Liquidations – entrepreneurs’ relief should not be assumed

By Ensors Team
18th May 2018

Liquidation is often seen as the final stage in the lifecycle of a company.  It has also been historically seen as an opportunity to extract cash in a tax efficient manner but changes introduced in 2016 which can be overlooked have complicated matters for owner managed businesses. 

The historical position

Until relatively recently, a typical (and commonly used) planning route was, say, for a company owned by individual shareholders to be liquidated after the sale of the company’s trade and assets or, often, after the sale of constructed or developed property.  Post corporation tax profits arising on the sale would be paid out as distributions to the shareholders in the course of the liquidation.  Tax law treated such dividends as being capital payments for the “disposal” by the shareholders of the shares held in the company.  This potentially allowed entrepreneurs’ relief to be claimed which could give a 10% tax rate on taxable gains made by the shareholders.  Even where entrepreneurs’ relief was not available, the rate would still be 20%.

The ability to extract profits from a company which had ceased its commercial purpose at a 10% or 20% rate, as opposed to a rate of 38.1% if a pre-liquidation dividend had been paid, is clearly attractive.  The use of liquidations was therefore common and the favourable tax benefits that could arise were not generally seen as stemming from tax avoidance.

A reminder of the 2016 changes

Unfortunately, with effect from 6 April 2016, the Government provided HMRC with two ways of attacking the use of liquidations.  If either of these are invoked by HMRC then, broadly, liquidation distributions will be taxed at dividend income tax rates (it should be noted that a “simple” sale of a company’s shares continues to be taxed under capital gains tax rules).

A. Anti-phoenixing “Targeted Anti-Avoidance Rule” (TAAR)

These rules can be applied by HMRC on liquidation distributions paid to individuals where the following conditions all arise:-

1. Immediately before the liquidation, the individual in receipt of the dividend had at least a 5% interest in the company.

2. At any time in the two-year period beginning on the date the distribution was paid either:

  • The individual carries on a trade or activity which is the same as or similar to that carried on by the company in liquidation; or
  • The individual, or a connected person (such as a family member), has at least a 5% interest in another company which carries on such a trade or activity; or
  • The individual is “involved with” the carrying on of such a trade or activity by a person connected with them.

3. A main purpose of the liquidation is the avoidance or reduction of a charge to income tax.

Whilst the first two points are largely factual tests (albeit that point 2 imposes considerable restrictions), the final point clearly introduces a degree of subjectivity, and there is no advance clearance procedure whereby HMRC’s views can be obtained.  Whilst the target of the legislation was held to be abusive arrangements whereby, for example, an individual would build up a business, extract the accumulated profits at a 10% tax rate via a liquidation and then immediately recommence the business in a newly formed company, the legislation can potentially attack normal commercial arrangements.  A particular concern is property construction or development where it is normal, in order to ring fence risk, for individual projects to be undertaken by separate companies.  HMRC have not given any assurances that such commercial structures will not be targeted.

The TAAR is contained within self-assessment, so interest and penalties would be in point if an individual returned their liquidation distribution as capital gains, and HMRC reclassified it to be income.

B Transactions in securities

Also, with effect from 6 April 2016, the Government extended the existing “transactions in securities” rules to encompass liquidation dividends.  Under this legislation, if HMRC can now demonstrate that a shareholder receives an “income tax advantage” because of a liquidation dividend and this was the main purpose, or one of the main purposes, of the dividend, this anti-avoidance legislation would apply.  (For these purposes, an income tax advantage arises if the amount of capital gains tax payable on the dividend is less than the income tax that would have been payable if the company had, pre-liquidation, paid the amount as a “regular” dividend.) 

As an example, if at the time that a company is put into liquidation the company has substantial undistributed post tax profits, there is a risk that HMRC may argue that an income tax advantage arises to the shareholders as the reserves could have been paid pre liquidation as dividends.  A clearance procedure exists whereby the taxpayer’s rationale for the liquidation dividend can be put to HMRC and comfort can be obtained that HMRC will not use this legislation.  Unfortunately, HMRC have stated in their published manuals that such a clearance, if obtained, does not extend to the above anti-phoenixing rules.


The changes brought in from 2016 have greatly “muddied the waters” in terms of the use of liquidations for tax planning purposes.  However, liquidations undertaken solely for commercial purposes should not fall foul of this legislation, and so the Members’ Voluntary Liquidation (MVL) will still very much have its place to extract retained funds at the end of a company’s life.  However, the subjectivity of the new rules means that even then, the tax treatment is not as clear as it used to be.  Professional advice should therefore be taken before any members’ voluntary liquidation is entered into.