Distributions made by a company to its shareholders are generally taxed as dividends at the following rates in excess of the £5,000 dividend allowance:
| Basic rate taxpayers | £0 - £33,500 | 7.5% |
| Higher rate taxpayers | £33,501 - £150,000 | 32.5% |
| Additional rate taxpayers | > £150,000 | 38.1% |
Where a company has ceased to trade and the shareholders wish to extract the accumulated reserves, they can commence a Members Voluntary Liquidation (MVL) and appoint a liquidator to wind up the company and pay out its profits. Any distributions made to shareholders by the liquidator are treated as disposals / part disposals of their shares in the company and therefore as capital disposals for capital gains tax (CGT) purposes.
CGT rates are currently lower than income tax rates and if the shareholders qualify for Entrepreneurs’ Relief, they have a lifetime allowance for chargeable gains of up to £10m under which their CGT rate is 10%. Contrast this rate to the highest dividend rate above and there emerges an incentive to certain taxpayers to manufacture a situation that results in the lower rate.
The ‘2 year’ rule
The government introduced an anti-avoidance measure in April 2016 that can apply to the above situation. Broadly speaking, HMRC can counteract the tax treatment where a company is wound up, the shareholders receive their distribution at CGT rates and then continue in business, within two years of the distribution being made, along the same or similar lines to the company that has been liquidated.
This is aimed at so called ‘phoenixism’, and although HMRC have held powers for many years to counteract this type of practice, the 2 year rule seeks to put beyond doubt what is being targeted.
Where a shareholder can demonstrate that, having regard to all the circumstances, the main purpose (or one of the main purposes) of the winding up is not the avoidance or a reduction of an income tax charge, the 2 year rule will not bite.
As this measure is still relatively new, we have yet to see it applied in the courts, but it may only be a matter of time until HMRC take a case.
The information in this article is believed to be factually correct at the time of writing and publication, but is not intended to constitute advice. No liability is accepted for any loss howsoever arising as a result of the contents of this article. Specific advice should be sought before entering into, or refraining from entering into any transaction.