QUESTION: I own all of the shares in a company carrying on a trading business. I started the business from scratch and my shares have only a nominal original cost. I have decided to retire. I cannot sell the business so I have decided to have the company wound up and I understand that I will pay tax at 10 per cent on the liquidation proceeds which are estimated at £750,000. Is this correct?
ANSWER: Up until the UK 2016 Finance Act, the answer to this question would probably have been ‘yes’. However HMRC recognised that there were signs of abuse of Capital Gains Tax (CGT) Entrepreneurs’ Relief (ER) which essentially charges qualifying gains made by qualifying individuals to CGT at a 10 per cent rate subject to a lifetime limit of £10 million. ‘Serial’ entrepreneurs were forming companies, trading for short periods of just over a year and then liquidating the companies and extracting the proceeds at 10 per cent after an ER claim. Soon afterwards they were back in business in more or less the same trade. The 10 per cent tax rate on extraction of the cash from the company is much less than the highest rate of dividend tax – 38.1 per cent, thus creating an incentive to attempt to convert income into gains.
The change in tax legislation introduced in this area in 2016 introduced anti-avoidance measures to combat taxpayers seeking to convert income into gains. In essence, the new rules seek to attack ‘phoenixism’, namely, starting a new business soon after winding up a previous one.
Unfortunately the new law is very complex and applies a series of tests which the taxpayer is expected to self-assess themselves against when contemplating winding up a company (technically known as a member’s voluntary liquidation or MVL). These tests comprise four conditions (A-D). The fine detail of these if beyond the scope of this reply however the most important one is arguably Condition C which states that if at any time within a two year period commencing at the date of the MVL pay out the taxpayer begins carrying on the same or similar trade as that carried on by the company which they have just wound up, then HMRC can challenge the capital distribution and treat it as an income distribution – a dividend. The difference in tax is very significant. In your own circumstances, with a £750k distribution on liquidation, the tax is either £75,000 (capital) or potentially £286,000 (income) so it is vitally important that the circumstances of your case are researched fully with particular attention being paid as to your future intentions post ‘retirement’.
If there is any chance that you could end up back in the same or similar business within two years then that could prove very costly in tax terms for you.
:: Paddy Harty (p.harty@pkffpm.com) is director at PKF-FPM Accountants (www.pkffpm.com). The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.
