On 6th April 2016, HMRC introduced Targeted Anti-avoidance Rule (TAAR) legislation to prevent individuals trying to avoid income tax via ‘phoenixism’.
Prior to this, individuals who intended to continue carrying on the company’s activities would wind up the company to receive the company’s undistributed profits. These profits would be classed as a ‘capital distribution’, rather than a dividend or other income distribution. This meant the individual paid tax at a lower rate (i.e. the Capital Gains Tax rates rather than the Income Tax rates) and after this would then carry on the same or similar activity using a newly-formed company.
The TAAR applies to distributions made on or after the 6th April 2016 if all of the following conditions are met:
- Condition A: The individual receiving the distribution had at least 5% interest in the company immediately before winding up
- Condition B: The company was a close company at any point in the two years ending with the start of the winding up
- Condition C: At any time within the period of two years beginning with the date on which the distribution is made, the individual carries on a trade or activity which is either the same as the company or very similar
- Condition D: It is reasonable to assume that the main purpose, or one of the main purposes of the winding up of the company is the avoidance or reduction of a charge to income tax
HMRC have advised that they are aware of schemes that are being advertised that are claiming to be able to “get around” this legislation and ensure that Income Tax would not be due on these distributions, for example they might suggest selling the company to a third party rather than winding it up.
HMRC will examine any efforts to avoid the Income Tax charge in this way. They have clarified that these schemes do not work because in most cases the outcome (receiving distributions in a winding up which are taxed as capital instead of income then carries on trading) is still within the scope and purpose of the TAAR legislation.
If it’s claimed that the TAAR does not cover the arrangements, HMRC will then consider whether the General Anti-abuse Rule (GAAR) applies to these schemes instead. Transactions after 14 September 2016 where the GAAR applies will be subject to a penalty of 60% as a user of the scheme.
Those who are using these schemes, or similar, will need to declare the distributions received as income in a self assessment tax return. If is too late to file a return, they will need to contact HMRC to settle the missing tax amounts.
