The Government is concerned that the new higher rates of income tax that have applied to dividends since 6 April 2016 may tempt some shareholder / directors to extract value built up within their companies in a capital form, rather than paying out the retained profits as dividends. This is because capital gains are generally taxed at a lower rate than income, possibly as low as 10% where entrepreneurs relief is available.
For example, a higher rate taxpaying shareholder receiving £100,000 on the liquidation of his company would pay £32,500 (32.5%) if the anti-avoidance applies, whereas CGT would be just £10,000 (10%) if entrepreneurs relief is available. Consequently, new stricter rules are being introduced to apply to transactions on or after 6 April 2016.
When is a liquidation taxed as income?
For the new anti-avoidance rules to apply, the company being wound up must firstly be a close company and the individual must have held at least a 5% interest in the company (ordinary share capital and voting rights).
A further condition is that the individual (or connected person) continues to carry on the same or a similar trade or activity to that carried on by the wound-up company within the two years following the distribution.
It must also be reasonable to assume, having regard to all of the circumstances that the arrangements appear to have a tax advantage as one of the main purposes.
Can we obtain clearance prior to the liquidation?
Accountants and tax advisors requested that the new anti-avoidance rules should provide a formal clearance procedure prior to the transaction, thus providing certainty as to whether or not the payment would be taxed as income or capital. Unfortunately, there is no formal clearance procedure. HMRC have however received a number of clearance requests from taxpayers and have confirmed that it is not their general practice to offer clearances on recently introduced legislation with a purpose test.
HMRC have therefore drafted a standard reply that sets out a small number of examples and they are working on more detailed guidance, which should be published before the end of this year.
This is a very complex area and we suggest that you contact us before you consider liquidating your company.