Beware New Rules on Liquidations – HMRC Refuse to Give Clearance

As you may be aware, new rules are being introduced with effect from April 2016 as part of the Finance Act 2016.  These relate to distributions in a winding-up/liquidation and are designed to target certain company distributions in respect of share capital in a winding-up. Where a distribution from a winding-up is caught, it is chargeable to income tax rather than capital gains tax.

The rules apply where the following conditions are met:

  1. The company being wound up was a close company (or was within the two years prior to winding-up)
  2. The individual held at least a 5% interest in the company (ordinary share capital and voting rights).
  3. The individual continues to carry on the same or a similar trade or activity to that carried on by the wound-up company within the two years following the distribution
  4. It is reasonable to assume, having regard to all of the circumstances that there is a main purpose of obtaining a tax advantage.

Whether or not Conditions C or D are triggered could be a cause for some contention, and so HMRC note that they have received a number of clearance applications relating to these new rules.

In the absence of a statutory clearance procedure under the new legislation, HMRC have clarified that it is not their general practice to offer clearances on recently introduced legislation with a purpose test.  They have instead sent out a standard reply providing some examples of how they think the rules will apply.

Clearly this is a developing area and HMRC’s reaction is somewhat disappointing as taxpayers often require certainty before carrying out commercial transactions which could be caught.  HMRC have stated that further guidance will be published, however in the meantime we advise that care be taken, and seeking professional advice, as always, may save time and costs in the long run.

We would be delighted to assist if you think you may be affected by these rules and have any queries.

Entrepreneurs’ relief – What is an ordinary share?

We have written in previous blogs about the need to take care over Entrepreneurs’ relief (ER) and preference shares (see Entrepreneurs’ Relief – 5% Test and Preference Shares) and a recent case heard by the First-Tier Tribunal has shed more light on how the rules are to be interpreted.

One of the conditions for ER is that the taxpayer must hold at least of 5% of the company’s ordinary share capital and voting rights. For these purposes, ordinary share capital is defined as all share capital excluding fixed rate preference shares.

However, in the recent case of M & E McQuillan v HMRC [2016] TC05074 redeemable non-voting shares which did not carry rights to dividends were found to not constitute ordinary shares for ER purposes.  It was found that shares with no rights to dividends could be considered as having a right to a fixed rate of 0% and therefore could be excluded from the calculation of ordinary share capital.

In this case, this provided the right outcome for the taxpayers as they were selling their ‘ordinary’ shares in the company, of which they had 33% each.  Another couple had made a loan of £30,000 which had been converted into the 30,000 preference shares which were redeemable non-voting share capital with no rights to dividends.

Had the 30,000 extra shares have been treated as ordinary share capital, the taxpayers would not have had the required 5% holding.

The case highlights the importance of checking through all the details before making a sale of shares in your company.  In this case, the taxpayers were successful but others will not be so fortunate.  Eaves and Co have extensive experience advising on share sales and Entrepreneurs’ relief and would be delighted to hear from you if you are considering a sale in the near future.

New Changes Restrict Reliefs for Goodwill But Options Still Remain

Two changes were announced in the Autumn Statement to the treatment of goodwill on incorporation, which had immediate effect from 3 December 2014.

These were as follows:

  • Entrepreneurs’ Relief is no longer available on a sale of the goodwill to a connected party
  • Tax relief on writing off the goodwill (amortisation) can no longer be obtained once in the company.

Both of these changes will reduce the attractiveness of common planning which was undertaken when incorporating a business, but there are still options available to avoid tax becoming a drawback on incorporation.

The use of TCGA 1992, s.162 incorporation relief, in combination with s.165 gift relief where suitable, is still possible in order to avoid upfront capital gains on incorporation.

It should also be noted that the new restrictions only apply where the parties are connected, and there could therefore be situations where suitable planning could be undertaken to prevent the rules from applying.  Similarly, in cases of a management or third-party buy-out, these new restrictions should not apply.

With further tightening of the rules, it will be more important than ever to ensure suitable professional advice is sought before undertaking an incorporation as careful structuring will be needed to avoid unexpected outcomes.

Entrepreneurs’ Relief Case

Here’s an interesting one!

In Corbett [2014] TC 3435 the taxpayer succeeded with a claim for Entrepreneurs’ Relief, despite having told HMRC some time before that she had ceased to be an employee.

To summarise the facts;

  1. Mrs Corbett was the wife of a senior executive and worked as a clerical assistant, especially in dealing with his diary and frequent marketing trips.
  2. The shareholders (who included Mrs Corbett) were negotiating to sell the company shares.
  3. The potential purchaser, an AIM listed company told them it was ‘against their policy’ for the wives of senior executives to be employed by their Group.
  4. HMRC argued that her resignation, recognition of her as a leaver on form P14 and the fact she was awarded no personal remuneration after leaving meant there was no employment, so the relevant condition of being an employee for the 12 months proceeding sale could not have been fulfilled so no Entrepreneurs’ Relief was due.
  5. The taxpayer argued that the change was cosmetic and her husband received extra remuneration to compensate for her carrying on her pre-existing employment.

Conclusion

The First Tier Tribunal found in favour of the taxpayer, saying that the substantive point of the matter was that employment continued, and potential technical breaches of the minimum wage regulations etc., were irrelevant.

Comment

Whilst no doubt Mrs Corbett was delighted with the result, it may have been less stressful to her if she had planned matters more carefully and made sure her tax planning documents reflected what the courts finally agreed was the substance of the situation.

Use advance planning and professional advice to make life easier!

Entrepreneurs’ Relief and Cessation of Trade – Rice v HMRC

The First-Tier Tribunal was asked to examine whether a significant change in business was in fact a cessation of one trade and the establishment of another. If so, the taxpayer would be able to claim Entrepreneurs’ relief against chargeable capital gains, in this case arising on the disposal of a property used in the original business.

Background

Mr Rice (the ‘Appellant’), was a sole trader selling used sports cars under the name ‘Performance Cars’, from his premises on Fletton Avenue, Peterborough. The business was heavily dependent on passing traffic for trade, with the sales-garage conveniently located on one of the main roads heading into Peterborough. Unfortunately Mr Rice found that he was suffering from increasing vandalism and was forced to re-evaluate the business model.  He sold the premises on 29 April 2008.

However, Mr Rice claimed that the business at Fletton Avenue had ceased in May 2005, almost three years prior to the sale of the premises. Evidence from Peterborough City Council supported his claims and showed that his property had qualified for Empty Property Rates Relief from 1 September 2005.

Mr Rice resumed selling used cars, but this time from a field adjoining his home in a nearby village outside Peterborough.  He renamed the business ‘Four Acres Car Sales’ and had the intention of continuing where he had left off, however Peterborough Council would only grant him planning permission providing he did not display vehicles for sale to the general public. Mr Rice resolved this problem by advertising on the internet, whereby potential customers made an appointment prior to the viewing of a vehicle. Mr Rice also decided to concentrate on selling four-wheel drive vehicles and family cars as opposed to the expensive sports cars.

When the original premise on Fletton Avenue was sold, Mr Rice made a capital gain of £274,649 on which he claimed Entrepreneurs relief.

HMRC’s Case

HMRC opened an enquiry into the Entrepreneurs’ relief claim and argued that the business had ‘relocated to the grounds of (his) private residence from where trading continued more or less as before’ and denied that there had been a cessation of trade.

The Decision

The Fist-Tier Tribunal acknowledged that the trade no longer relied on passing traffic and that Mr Rice switched from selling sports cars to family cars. For these reasons they accepted the fact that very significant changes in the way in which business activities were conducted.

It was agreed that these changes constituted a cessation of trade, with the cessation taking place within the three year requisite period.

The taxpayer was therefore entitled to Entrepreneurs’ relief, and his appeal was allowed.

Entrepreneurs’ relief on Enterprise Management Incentives (EMI) share options

One of the problems with Entrepreneurs’ relief as opposed to the old rules on Business Asset Taper Relief, was that employee shareholders could struggle to acheive the relief due to the 5% holding requirement.  This position has now been relaxed where shares are acquired through an Enterprise Management Incentives scheme, meaning it should now be easier to obtain Entrepreneurs’ relief on Enterprise Management Incentives (EMI) share options.

Draft proposals under the Finance Bill 2013 will remove the requirement for a person to hold at least 5% of the ordinary share capital of a company in order to qualify for entrepreneurs’ relief on shares acquired through a qualifying EMI share option scheme.

The legislation will also be changed to allow the period in which the options are held to count towards the 12 month holding period required to qualify for entrepreneurs’ relief.

These announcements will therefore increase the already highly efficient tax treatment of EMI schemes, and potentially enhance the incentivisation of employees under such schemes.  Even where the share option scheme itself is not desired, EMI schemes could potentially be used to enable employees to acquire shares that will qualify for Entrepreneurs’ relief, as there is no minimum exercise period for EMI options.

Entrepreneurs’ relief on the disposal of land – William S G Russell v HMRC (TC02299)

A recent first-tier tribunal case (William S G Russell v HMRC (TC02299)) involved a claim for Entrepreneurs relief (ER) on the disposal of farm land.

Mr Russell was a one third partner in a farming business, run with his brother and sister-in-law.   Some farming land that was disposed by the partnership was agreed as being 35% of the land that that was capable of being farmed.

Mr Russell made a claim for Entrepreneurs’ relief (ER) on the basis that the sale was a material disposal of a business asset.  His main argument was that as there was a fall in profit that tied in with the percentage of land sold and the land sold was still being farmed, it therefore constituted a business.

The tribunal found that the sale did not amount to the disposal of a business, simply a disposal of a business asset.  This was because the business was being run in exactly the same way following the sale.

Interestingly, it might have been possible to successfully claim for Entrepreneurs’ relief had Mr Russell undertaken suitable planning before the sale.  A disposal of even a small part of his partnership share would have allowed the land sale to be an associated disposal.  Incorporation could also have been used in order to effect a cessation of the partnership business, thus allowing a claim for an associated disposal.

Planning before transactions take place is essential to ensure that any potential problems can be identified before they arise.  Please contact us if you are planning to dispose of assets in our Leeds office on 0113 2443502.

Entrepreneurs’ Relief – More Beneficial Than Ever

 

The recent changes in rules on Capital Gains Tax and Entrepreneurs’ Relief mean that it is more important than ever.  With the main rate of CGT now 28% and the rate on assets qualifying for ER remaining at 10%, the benefit of attaining ER is increased to 18% from the previous 8%.  Coupled with the lifetime limit increase to £10m, the overall lifetime value of ER is a maximum of £1,800,000; a significant increase on its initial value of £80,000.

It is therefore more important than ever to fully consider the availability of ER on transactions and ensure that all the conditions are met.