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HMRC internal manual

Company Taxation Manual

Particular topics: company winding up TAAR: condition D

ITTOIA05/S396B/404A (5) and (6)

Where conditions A, B and C are satisfied S396B/404A will still not apply unless Condition D is also met. S396B/404A (5) applies Condition D where:

 “it is reasonable to assume, having regard to all the circumstances, that –

  1. The main purpose, or one of the main purposes of the winding up is the avoidance or reduction of a charge to income tax, or
  2. The winding up forms part of arrangements the main purpose or one of the main purposes of which is the avoidance or reduction of a charge to income tax”.

S396B/404A (6) provides further guidance on the purpose test:

“The circumstances referred to in subsection (5) include in particular the fact that Condition C is met.”

S396B/404A (5) requires that regard is given “to all the circumstances”, whereas S396B/404A (6) states that the circumstances should be specifically considered in relation to the fact that Condition C is met. Consideration will therefore be given in particular to whether the tax advantage is a consequence of the winding-up and the continuing involvement with the  carrying on of the same or a similar trade or activity.

Ultimately, the legislation is asking whether the recipient of the distribution is continuing what amounts to the same business having extracted the accumulated profits in a capital form. 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?

It is impossible to give an exhaustive list or comprehensive examples as individual facts and circumstances will be paramount. The aim is to establish whether it is reasonable to assume that the company was wound-up as a way of converting into a capital transaction what would otherwise have been paid out as income. The essential question is whether an individual may reasonably be regarded as carrying on or continuing to be involved in the carrying on of the same business as before, having extracted the profits in a capital form.

A decision by a company and its shareholders not to make an income distribution prior to the company’s being wound up does not, by itself, mean that the main purpose test is met.

The individual will know their purpose and, if fairly described, can be confident that there will be enough supporting evidence (“having regard to all the circumstances”) for an officer to arrive at a sound conclusion when applying the test of whether it is ‘reasonable to assume’ that a main purpose of the winding up or the wider arrangements was the avoidance or reduction of a charge to income tax. The individual should self-assess on that basis. HMRC can only displace this self-assessment where the individual’s decision is not reasonable.

The purpose test is subjective but the purpose may be inferred from objective characteristics having regard to all the circumstances surrounding the winding-up to which the test is being applied, much as Lord Brightman was able to draw an inference in a different context.  In Mallalieu v Drummond  (1983) 57 TC 330 he was able to distinguish between the motive the barrister asserted of maintaining a wardrobe of a certain type and standard, and the object or purpose of the purchase of it.

The main purpose test is applied by reference to intentions known at the time the decision was made to wind up the company. However, this will be evidenced by what happens after the winding up occurs and it is likely that, in order to test assertions in relation to the main purpose, officers will review all available evidence.

Where a company is wound-up as part of a series of transactions designed to refine or restructure the commercial architecture Condition D is unlikely to be met.

Subject to the facts of the case, where Condition C is met due to an individual remaining ‘involved with the carrying on of’ a trade as an employee, rather than as an owner, shareholder or partner, and has no involvement in or influence over the direction or decision-making of the entity carrying on the activities, it is less likely that Condition D will be met.