Guidance

Attempts to avoid an Income Tax charge when a company is wound up (Spotlight 47)

Information about tax avoidance schemes that try to avoid an Income Tax charge on distributions when winding up a company.

Overview

HMRC is aware of schemes that claim to avoid the Income Tax charge for shareholders when winding up a company.

The schemes try to receive favourable Capital Gains Tax rates rather than Income Tax treatment, by changing the way shareholders take value out of their companies.

How distributions could be dealt with to 6 April 2016

Until 6 April 2016, distributions in a winding up were used by some individuals to avoid Income Tax. An individual (who may be acting alone or with others) who intends 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 ‘capital distribution’, rather than a dividend or other income distribution. This meant the individual paid tax at a lower rate. They would then carry on the same or similar activity, often using a newly-formed company.

This is often known as ‘phoenixism’.

Changes from 7 April 2016

In 2015 the government announced new Targeted Anti-avoidance Rule (TAAR) legislation to end this type of phoenixism and stop individuals from gaining a tax advantage by winding up companies, to make sure any distribution in the winding up is taxed as income, rather than being subject to Capital Gains Tax.

How the avoidance schemes work

Some scheme promoters claim to have come up with schemes that avoid the Income Tax charge and get around the TAAR legislation.

They claim that by making an artificial modification of the arrangements aimed at defeating the intention of the legislation (by selling the company to a third party rather than winding it up, for example) the TAAR will not apply.

Why you should not use these schemes

These schemes do not work because:

  • in many cases, the actual outcome is that the individual is receiving distributions in a winding up - as the individual carries on trading using a different vehicle these schemes are within the scope and purpose of the TAAR legislation
  • phoenixism arrangements that claim to involve payments to shareholders taxed as capital instead of income are caught by the TAAR, or other provisions

HMRC will investigate any attempts to avoid the Income Tax charge.

If it’s claimed that the phoenixism TAAR does not cover the arrangements, HMRC will consider whether the General Anti-abuse Rule (GAAR) applies to these schemes.

Transactions after 14 September 2016 where the GAAR applies will be subject to a 60% user penalty.

For transactions entered into on or after 16 November 2017, any person who enabled the use of these sorts of schemes may be subject to a penalty as an enabler of an abusive scheme.

The penalty amount will be equal to the amount of consideration they received for enabling the arrangements. The user may also be subject to penalties for filing an inaccurate return, with penalties of up to 100% of the undeclared tax.

What to do if you’re using one of these schemes

You should declare income distributions of the amount you receive in your tax returns if you’re using one of these schemes, or something similar.

If time limits have passed and you can no longer file a return, you should settle with HMRC to avoid accruing interest.

If you’re using a phoenixism scheme and are already speaking to someone at HMRC, you should contact them.

Email: reconstructions@hmrc.gsi.gov.uk if you have not already spoken to someone at HMRC.

Get more information

You can find more details about the 2015 legislation changes in:

Find out how to identify tax avoidance schemes.

Published 4 February 2019