What is “anti-phoenixing” and how could it affect you

Whenever we discuss winding up a solvent company, the procedure we talk about is a members’ voluntary liquidation (MVL). 

As well as being the most appropriate vehicle it is generally the most efficient for tax purposes for directors too – as proceeds are received as a capital distribution rather than a dividend so would be able to take advantage of lower capital gains tax rates as a result. 

Is an MVL too good to be true?

A question that occasionally arises from directors considering closing their business using this method is “are you sure this is legitimate?”

One of the reasons they ask this question, apart from it can seem too good to be true, is that they might have read about two specific law changes that came into effect in 2016 and had an effect on legitimate tax planning. 

The first is under something known as “transactions in securities” legislation where HMRC would target directors or shareholders who they deemed had tried to avoid income tax by virtue of a distribution made in the course of a winding up through an MVL.  

The second was legislation specifically introduced to tax shareholders on their capital distributions on a winding up as though they had received dividends – which would mean the higher tax rates of up to 39.35% rather than the 10% to 20% applicable under capital gains tax would apply. 

This was meant to tackle the process known as “phoenixism” – where an individual forms a company to run their business, accumulates income as usual, winds the company up through an MVL and then starts the business again under another newly formed company, repeating the process every couple of years.  The result being that they only pay capital gains tax on accumulated income at the lower rate. 

It’s perfectly acceptable for the authorities to target phoenixism and introduce legislation to do so but would this make the process of tax planning in this way unreasonable?  

The point of tax planning is to legally reduce the tax burden on companies and as capital gains have always been taxed at lower rates than dividends; and there is no obligation on a company to pay a dividend, then the planning simply took advantage of the different rates available. 

Many experts now point to the legislation itself saying it is so widely and potentially inaccurately drawn that it could be applied in circumstances that are nowhere near phoenixism.

Grounding the phoenix

The higher tax rates would apply under the legislation if:-

  • A director has at least a 5% interest in the company
  • The company is under the control of five or fewer shareholders when it is wound up or at any time in the two years preceding the winding up process beginning
  • If, at any time within two years of the capital distribution, the director carries on a trade or activity which is the same as or similar to that carried out by the company or a subsidiary – this also includes partnerships or if a company in which they or someone connected to them has at least a 5% interest and if they are involved with the carrying on of such a trade or activity by a person connected with them
  • Regarding all the circumstances, if one of the main purposes of winding up the business is the avoidance or reduction of a charge to income tax

You can easily see circumstances and scenarios in which a director or shareholder might find themselves worried that they have inadvertently contravened these conditions. 

There is no definition of what a similar trade or activity is. Nor is there a definition of what being involved with a trade or activity means. 

The legislation applies when “it is reasonable to assume” that income tax avoidance is one of the main purposes of winding up but this wording means that the legislation could apply if nobody had such a motive, just as if it was just as reasonable to assume they did. 

Legislation drawn so generally creates the potential for discretion to be exercised by HMRC inconsistently leading to unfair outcomes. For instance the official HMRC manual misstates the legislation on several occasions and suggests that an important factor is whether the shareholder or director has control of the trade or activity after the winding up, which isn’t mentioned in the legislation itself!

Shareholders who receive capital distributions on a winding up have to decide whether to include the gains as capital or dividends on their tax returns but there is understandably uncertainty as to whether the anti-phoenixism legislation would apply. 

HMRC doesn’t operate a clearance procedure for the legislation but under the separate “transactions in securities” legislation, there is an advance clearance procedure so directors applying for clearance prior to the closure means that HMRC accepts that the transactions in securities legislation will not apply. 

While this clearance only applies to transactions in securities legislation, not anti-phoenixism, by issuing a clearance HMRC would accept that none of the main purposes of winding up the business is to obtain an income tax advantage so this would make it harder for them to later argue that the other anti-phoenixism legislation should apply.

This legislation is another good example of why, if any more were needed, that you should listen carefully to your accountant

They will be able to spot these potential landmines before you are close to setting any off and should be your trusted early warning system on whether a business is approaching financial difficulties in advance. 

We offer a free initial consultation to any director or business owner who wants some professional advice on how they can improve their prospects. Together with regular consultation with their accountant, they should have all the accurate and pertinent information at their fingertips to act before any situation becomes critical.