The latest topic that has come up regularly on our helpline relates to the Phoenixing rules. It comes as a surprise to some that it does not just catch serial companies and can affect individuals setting up as self-employed as well.
Most of us thought that the rules were brought out to stop people taking funds from their companies at the 10% CGT rate by simply liquidating them and setting up again the next day under a new company. This is caught but the rules are much wider than that.
To see how this can affect transactions we need to look at the HMRC Corporation Tax manual. At CTM 36300 etc the rules are set out fairly clearly. The rules are contained in ITTOIA 05 S404A and 369B. The section of the manual is called “company winding up TAAR”. So the rules should be targeted but we will see that the target appears to be wide and probably uses a scattergun rather than a sniper rifle.
There are basically 4 conditions that need to come into play for the rules to catch. A and B are fairly general and really only drag in any liquidation that could get ER. It is C and D that we need to look at.
It is C where the interpretation is very wide. In fact, the manual says:
The condition is widely drafted to prevent the rule being easily avoided by subtly changing the type of trade or activity of the company, or by changing the structure in which that trade or activity is carried out (for example by transferring the company’s trade to a partnership).
So basically they are looking at anything that can be used to continue in the same trade or business after getting funds from a company by way of CGT and ER. The manual has a number of examples of what is and what is not a similar trade or activity. For instance:
Mr G is the sole shareholder in a company that provides a car-washing service. Mr G winds up that company but continues to provide car-washing services through a partnership with his wife, but now also sells air-fresheners.
Clearly, Mr G is carrying on the same trade, or at least a trade very similar to that carried out by the company, and so Condition C is satisfied.
Mrs F is a landscape garden designer and runs her business through a company. Mrs F decides she would like to retire, and so winds up the company. In order to supplement her pension, and because she enjoys it, Mrs F continues to provide routine gardening services to a small group of clients in her local village as a sole-trader.
It is unlikely that Mrs F is carrying on “the same trade” after the winding up as that carried on by the company. However, the provision of gardening services is “similar to” the provision of landscape gardening, and so Condition C is met.
Mrs C is an accountant who runs her business through a company. Her husband is a self-employed lion tamer. Mrs C winds up her company and starts work for a newly-formed company owned by her husband, providing accountancy services.
Mrs C continues to be involved in the same trade or activity as the wound-up company was involved with (the provision of accountancy services), even though she is now an employee rather than business owner. She is connected to her husband and so Condition C is met (and so are Conditions A and B).
Instead of going to work for a newly-formed company, Mrs C, from Example 1, goes to work for her sister’s pre-existing accountancy practice, which the sister operates as a sole trader.
Mrs C is connected with her sister, and she is continuing to be “involved with” the same or a similar activity, and so Condition C is met.
Mr B is a fitness instructor who provides his services through a company. After suffering an injury he winds up his company and starts work as a journalist. Mr B’s wife is also a fitness instructor and she offers her services as a sole trader, before and after the winding up of her husband’s company. Mr B provides no services to his wife’s business at all.
Mr B is not “involved with” a similar trade or activity after the winding up of the first company, even though his wife is.
As you can see condition C is very wide and does not exactly catch the cases we felt it was originally aimed at. However, Condition D gives us a way of clawing this back. S396B/404A (5) applies Condition D where:
“it is reasonable to assume, having regard to all the circumstances, 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, or
The winding up forms part of arrangements the main purpose or one of the main purposes of which is the avoidance or reduction of a charge to income tax”.
The HMRC manual outlines what they feel is relevant here. It says:
Is there a tax advantage, and if so, is its size consistent with a decision to wind-up a company to obtain it?
To what extent does the trade or activity carried on after the winding-up resemble the trade or activity carried on by the wound-up company?
What is the involvement in that trade or activity by the individual who received the distribution? To what extent have their working practices changed?
Are there any special circumstances? For example, is the individual merely supplying short-term consultancy to the new owners of the trade?
How much influence did the person that received the tax advantage have over the arrangements? Is it a reasonable inference that arrangements were entered into to secure this advantage?
Is there a pattern, for instance have previous companies with similar activities been wound-up?
What other factors might be present to lead to a decision to wind-up? Are these commercial and independent of tax benefits?
Are there any events apparently linked with the winding-up that might reasonably be taken into account? For example, was the only trade sold to a third party, leaving just the proceeds of the sale?
This clearly narrows down condition C but still leaves it open to HMRC’s interpretation which we all know can be “interesting”. For instance we have seen a number of times where they argue that even getting £1 advantage is significant if it helps their case. This can usually be overcome but still needs time and effort on our part.
We have had questions relating to a company with 5 director shareholders where there are three different scenarios as some are retiring, others becoming members of an LLP doing the same work and another being an employee of the LLP.
As the retiring directors are aiming to continue working in an advisory capacity they could be outside this if they fall under the fourth bullet point but we have had to suggest that this period is considerably less than the 5 years they were originally considering.
Of course there is always the ability to use the ER route for closing the company and then live off the proceeds for 2 years before starting again and thus avoid all these rules. Not all of us have that luxury however.
Basically you need to consider these rules if you are looking at winding up any company and obtaining ER. It is likely that the transaction is caught due to condition C but if this is not simply being done to get the ER on a lump of cash in a company there is a possibility that condition D will help to avoid any problems.