Antony Antorkas, Director, Parker Andrews
The Chancellor, George Osborne, announced in last year’s Autumn Statement that from 6th April 2016, dividends from limited companies that are currently tax-free will be taxed.
Compounding the misery for business owners, HM Revenue & Customs (HMRC) published a policy paper and draft legislation in the week prior to Christmas, which has shrouded shareholder eligibility for Entrepreneurs’ Relief (ER) in uncertainty.
These changes will have a negative impact on many business owners, particularly those accumulating cash within the company and paying salaries and dividends within tax-free limits. There are also ramifications for directors and shareholders seeking to place their company into Members Voluntary Liquidation (MVL).
What is a Members Voluntary Liquidation (MVL)?
At the end of the useful life of a solvent company, it is usual practice to place it into Members Voluntary Liquidation and distribute the cash to shareholders as a capital gain.
In some cases, shareholders who own 5% or more of a company that has been trading for at least 12 months are eligible to claim Entrepreneurs’ Relief (ER) and have the capital gain taxed at 10% rather than 28% (up to a lifetime limit of £10m).
Shareholders must also have been employed by the company for at least one year up to the date it ceases to trade.
An MVL allows for a quick appointment of a licensed insolvency practitioner to facilitate the distribution of funds to shareholders following retirement of the owners/directors, closure of the business, exit from markets in which the business operates, group reorganisation or simplification programmes, and mergers/demergers (including resolution of owner disputes).
As things stand, distributions made by a liquidator via an MVL may be treated as capital distributions, significantly lowering the potential tax liability to the recipient. Qualifying shareholders can also take advantage of the aforementioned Entrepreneurs’ Relief to further reduce their capital gains tax liability.
There was speculation that ER might be cut or scrapped altogether after the Budget on 16th March 2016, but Mr Osborne actually announced an extension of the relief.
For unlisted companies purchased on or after 17th March 2016, the 10% capital gains tax rate will be accessible to entrepreneurs who hold newly issued shares for a minimum of three years from 6th April 2016.
How to Ensure TAAR Compliance?
It’s clear that HMRC is seeking to introduce legislation to prevent serial users of the MVL procedure (and by implication, those using ER as a loophole to limit the tax on capital distributions to 10%) with a Targeted Anti-Avoidance Rule (TAAR).
The TAAR appears to be designed to combat the practice of “phoenixing”, whereby directors and shareholders use the MVL process to close their solvent company, extracting cash and assets without paying income tax and with a greatly reduced capital gains tax liability (via ER), before starting up a new company immediately afterwards.
The new HMRC policy paper states that distribution from a liquidated company will be treated (retrospectively) as income distribution, therefore subject to income tax and ineligible for ER, if three conditions are met:
- A shareholder in a close company receives a distribution in respect of shares in a winding-up
- Within a period of two years after the distribution, the shareholder continues to be involved in a similar trade or activity (directly or via an associate)
- The circumstances surrounding the winding-up have the main purpose, or one of the main purposes, of obtaining a tax advantage
Impact of New MVL Regulations
HMRC may investigate companies attempting an MVL once the new rules are enforced, but at the moment, it’s hard to say how strictly it’ll define “main purpose”.
Since the proposed changes were announced, we’ve noticed a sharp increase in MVL enquiries from directors and shareholders seeking to take advantage of the current system. A word of warning though; the MVL procedure requires an Extraordinary General Meeting (EGM) of the company, which in some cases requires a minimum 21-day notice period.
However, the majority of companies can hold the EGM with a shorter notice period, subject to the consent of the shareholders (minimum 95%). In addition, the company tax affairs ought to be up-to-date, so the latest possible date for applications is 30th March 2016.
The Clock is Ticking…
It certainly doesn’t help that most accountants are in the midst of their busiest time of year and the procedure is dependent on how promptly HMRC responds to the claims and requests necessary to complete the process. Some accountants have argued the new rules should only be applied to liquidations commencing on or after 6th April, rather than to distributions that happen after this date.
There’s a lot of uncertainty surrounding the draft legislation and directors who were contemplating a company closure via an MVL are now being moved to action.
Fundamentally, the MVL procedure isn’t changing, so in the long term we’re not expecting to see a reduction in the number of “genuine” MVL requests.
The Liquidator’s View
My colleague, licensed insolvency practitioner, Richard Cacho, has this to say;
“It’s important to note the MVL procedure has not changed in any way, instead the proposed changes relate to cases where the shareholders of a company in MVL are seeking tax relief, specifically Entrepreneurs’ Relief, in respect of their distributions.
“We believe the uncertainty surrounding the eligibility for Entrepreneurs’ Relief post 6th April 2016 is driving the increased demand for MVL we’re experiencing, as shareholders seek to close their companies prior to the proposed changes and look to have their distributions dealt with under the current tax rules.
“We are not tax advisers, however, we understand that shareholders seeking Entrepreneurs’ Relief under the present rules must receive all of their distributions, whether in cash or in specie, by 5th April 2016, i.e. all distributions must be made in the current tax year.”