The Targeted Anti-Avoidance Rules – implications for closing a company

What is the TAAR?

The Targeted Anti-Avoidance Rules (TAARs) have been with us for some time. First introduced in Finance Act 2016, it is now found in the Taxation (Trading and Other Income) Act 2005, section 396B, and is designed to prevent the former practice of ‘phoenixing’, whereby a shareholder, or shareholders, of a limited company would put a company into members voluntary liquidation and seek to take out the value of the business as capital, at capital gains rates of tax, rather than as income. The shareholder(s) would then create a new company doing something of the same (usually) or a similar nature and repeat the cycle potentially several times over.

How does it work?

If all four conditions of the legislation are met, then the distributions from the liquidator are taxed as income, up to a rate of 38.1% (39.35% for distributions from 6 April 2022), instead of the rate at which capital in a trading company is normally realised, being 10% or a maximum of 20%.

The Conditions

• Condition A: The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up
• Condition B: the company was a close company (or, for non-UK resident companies,  would have been a close company if it was a UK resident company) at any point in the two years ending with the start of the winding up
• Condition C: the individual receiving the distribution continues to carry on, or be involved with the carrying on, of the same trade or a trade similar to that of the wound-up company at any time within two years from the date of the distribution
• Condition D: it is reasonable to assume that the main purpose, or one of the main purposes of the winding up is the avoidance or reduction of a charge to Income Tax.

This does present the risk that the TAAR would apply if the shareholder liquidates their company and then starts to carry on the same or a similar trade, within two years from the date of the last capital distribution via:

• A sole trader
• A partnership
• A company
• An LLP
• An employee of a ‘connected person’

Why should I be concerned?

If you fall foul of Conditions A or B, they are clear cut.

Conditions C and D are less so, because there are no legislative definitions of:

‘to be involved with’ or ‘same trade or a similar trade’ and so we are left to determine those things for ourselves.

HMRC provides some guidance, but it is limited and seeks only to offer extreme examples, at CTM36325 and CTM36330.

For example, it is not uncommon for business owners to pursue business interests that align with their personal interests. When you retire, you may wish to continue in some capacity providing services of the same or a similar nature perhaps to supplement early years of retirement, or to ease into retirement. You may fall foul of Condition C.

HMRC gives the example of a landscape gardener who winds up her landscape gardening company and then becomes a general gardener. This, says HMRC, would be of a ‘similar nature’ and would be caught. HMRC also considers loft conversions similar to the building of extensions.

Other examples can be found in their guidance, and they all require a detailed review of the circumstances at the time of liquidation and the two years following a distribution.

But wait a minute…

It is fundamental to the legislation that the four requirements are met. Perhaps the trickiest of these to demonstrate for either HMRC or the taxpayer will be Condition D. It is a highly subjective ‘motive’ test and HMRC consider it to be narrowly drawn.

The burden for demonstrating a non-tax motive will be on the taxpayer and so rather than give examples, HMRC guidance provides a number of questions to consider in view of the facts as a whole. The list is not exhaustive and we would suggest offers no real quality to facilitate a positive conclusion- how very like HMRC!

HMRC says:

“This is inevitably a question of judgment to be made on the basis of facts in individual cases. The following issues are likely to be relevant:

• Is there a tax advantage, and if so, is its size consistent with a decision to wind-up a company to obtain it?
• To what extent does the trade or activity carried on after the winding-up resemble the trade or activity carried on by the wound-up company?
• What is the involvement in that trade or activity by the individual who received the distribution? To what extent have their working practices changed?
• Are there any special circumstances? For example, is the individual merely supplying short-term consultancy to the new owners of the trade?
• How much influence did the person that received the tax advantage have over the arrangements? Is it a reasonable inference that arrangements were entered into to secure this advantage?
• Is there a pattern, for instance have previous companies with similar activities been wound-up?
• What other factors might be present to lead to a decision to wind-up? Are these commercial and independent of tax benefits?
• Are there any events apparently linked with the winding-up that might reasonably be taken into account? For example, was the only trade sold to a third party, leaving just the proceeds of the sale?”

What is fails to address:

• What level of income will the individual derive from the trade or activity and how does that compare to their situation beforehand?
• What risk does the person have both in terms of public liability, employers’ liability and financial risk both before and after the liquidation?
• Did circumstances change between the winding up and the carrying on of the subsequent trade or activity (divorce, illness, loss of wealth) which forced the individual to go back to what they were doing?

And there will be other questions, no doubt, that could lead to a positive non-tax motive.

Changes to HMRC’s guidance in 2018 clarified:

1. a decision not to pay an income distribution before the winding-up does not mean that condition D is automatically met;
2. an individual is required to self-assess based on their own knowledge of the purpose of the winding-up, and HMRC can only displace this self-assessment where the individual’s self-assessment is not reasonable;
3. condition D must be assessed by reference to intentions at the time the decision was made to wind up the company, but HMRC will treat events occurring after the winding up as evidence of those intentions and want to look at all available evidence when assessing the main purpose;
4. condition D is less likely to be met where an individual remains ‘involved with the carrying on’ of a trade solely as an employee with no decision-making power or influence.

However, it would not be prudent to assume that retirement alone was a good enough argument to prevent HMRC being successful in a challenge, since the circumstances might be implicitly contradictory to retirement.

If you are thinking of winding up your company and wish to pursue activities of the same or a similar nature, then you should consider the foregoing carefully; and if you are passionate in your desire to proceed then taking advice on this matter is highly recommended. Otherwise, waiting more than 2 years from the final distribution should be considered.

Next steps

At UHY Ross Brooke, we have specialists in company administration, so if you are affected, then please get in touch and we would be happy to advise you.