This method of avoiding tax is known as ‘phoenixing’: the process of extracting profits from a company, without payment of a revenue dividend, by way of liquidation and then establishing a new company in the same trade (the phoenix company).
HMRC is looking to curb the use of phoenixing to avoid tax, but this focus will have a disproportionate effect on those for whom winding up companies to extract profits, before setting up in the same space again, is a legitimate part of their business process. Those using this process for genuine reasons and as a common part of their business practice – for example property developers – could now find themselves coming under scrutiny from the Revenue.
What then must companies do to avoid wrongly showing up on HMRC’s radar? Although described as a targeted anti avoidance rule (TAAR), it is nothing of the sort and instead adopts a “capture and discard” approach. The “capture conditions” mean that any distribution in liquidation by a private company is caught where the recipient shareholder, at any time in the following two years, carries on any trade or other similar activity to that previously carried on by the company. This applies whether this involvement is as a sole trader, in partnership or in a new company. The discard condition requires the application of a “main purpose test”: that it is reasonable in all the circumstances to assume that the main purposes of the liquidation was not for the avoidance of an income tax liability.
Should a similar company be commenced by the shareholders within two years then, on the face of it, the previous capital distribution must now be treated as a revenue dividend, dependent upon the “main purpose” found.
As yet, HMRC has not provided for any prior clearance procedure or given any guidance around phoenixing so we are likely to see uncertainty in many liquidations until some measure of experience is achieved. Businesses must therefore look to protect themselves by having a robust filing position that fully documents the commercial reasons for the winding up and ensures that adequate disclosure is made when reporting the resulting gain. In short; tread carefully and ensure you have the right reporting in place to avoid getting burnt.
Neil Simpson, Tax Partner, haysmacintyre
