HMRC Crack Down On Entrepreneurs Relief Claims On Cessation Of Business

January 31, 2017 1:58 pm Published by

HMRC have been dealing with a lot of cases challenging Entrepreneurs Relief claims on ‘Phoenix Companies’. The practice of ‘Phoenixing’ involves Directors setting up a company for a contract, then subsequently closing it down when the contract ends enabling them to claim ER tax on the business assets above the Capital Gains Tax allowance.

The directors then open up another company when they get a new contract and repeat the process. Unfortunately, poor advice has led some company Directors to carry out this practice without being aware of the negative light it is seen in by UK Company Law or for UK Tax.

In this blog, we look at ‘phoenixing’ and the new targeted anti-avoidance rules (TAAR) set in place to prevent people taking advantage of this practice and thus benefiting from lower tax rates.

How Did ‘Phoenixing’ Allow Directors To Take Advantage Of Lower Tax Rates?

Company Directors have taken advantage of CGT rates of tax on liquidation of the company, which could be as low as 10% with Entrepreneurs Relief, a much lower rate than the usual Income Tax rates.

Example:

The Director of an IT contractor wins a contract and sets up a company to carry out the contract.

Once the contract is completed, the director closes down the company and on liquidation claims Entrepreneurs Relief of 10% tax on assets above the Capital Gains Tax Allowance (£11,100).

When the IT contractor wins a new contract following this, they will then start all over again, setting up a new company and repeating the process.

In this case, the original company should never have been shut down – given the fact that the contractor had not changed their profession, they were just between contracts, this would be a red flag in the eyes of HMRC.

HMRC have now ruled that it will be impossible to get a tax advantage using these methods, under a specific set of anti-avoidance rules announced in the Finance Act 2016. It’s worth noting that Directors are still able to open and shut subsequent companies; so long as there is no intention to gain a tax advantage whilst carrying on the same trade.

Finance Act Changes – TAAR Rules

The new Targeted Anti-Avoidance Rules have been put in place to ensure that anyone shutting down a limited company and then opening a new company in the same trade would have to seek non-statutory clearance with HMRC.

The HMRC are then able to check that the winding up of the company is for genuine reasons and not for the sole purpose of phoenixing the company to gain a tax advantage. HMRC are not yet issuing these non-statutory clearance letters, but are due to publish full guidance in the next few months.

To prevent Directors taking advantage of CGT rates of tax, there are four conditions which if all met, mean the distribution from a winding-up is treated as income and therefore taxed as such:

A – The company must be a close company, this is a company that is privately owned and controlled by five or fewer individual participators.

B – The director must own more than 5% interest.

C – Within two years after the winding up of a company, the Director carries on in the same or similar trade or activity, this includes working for a spouse or connected party.

D – The circumstances are reasonable to assume that the purpose of the winding up is to obtain a tax advantage.

Currently, A – C are factual and D will then be determined by HMRC and will be challenged if there are indications of gaining a tax advantage.

Need A Hand?

Some Directors who get involved in bad practices such as phoenixing end up doing so from poor, outdated advice. At First Call Financials, we can give advice on the appropriate steps for your business in regard to the importance of understanding a Directors legal position within Company Law. For more information, give us a call on 0117 3790810, you can also sign up to our newsletter for the latest industry news.

 

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This post was written by Steph Roffey

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