HMRC Consultation Document: Company Distributions Response by the Chartered Institute of Taxation

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HMRC Consultation Document: Company Distributions Response by the Chartered Institute of Taxation 1 Introduction outline of the consultation 1.

1 HMRC Consultation Document: Company Distributions Response by the Chartered Institute of Taxation 1 Introduction outline of the consultation 1.1 This consultation 1 concerns the tax rules governing distributions by a company. It also covers the specific changes put forward in the draft legislation published in Finance Bill 2016 clauses 16, 17 and 18 and the distributions rules in general. 1.2 The Government says that it is concerned that the current distributions rules may be used to arrange for returns from a company to be taxed as capital rather than as income, attracting tax at lower Capital Gains Tax (CGT) rates. There may be an increased incentive from April 2016 when changes are made to the way in which dividends are taxed. 1.3 This consultation accompanies draft legislation 2 which amends the Transactions in Securities (TIS) rules in Income Tax Act (ITA) 2007 Part 13, which are designed to prevent a tax advantage from being obtained where a transaction is carried out where a main purpose, or one of the main purposes, of a party to the transaction is to obtain a tax advantage. HMRC say that this proposed measure will restrict the opportunities for shareholders to convert to capital what might otherwise be paid as an income distribution (most commonly a dividend). It will also align the counteraction process for the TIS legislation more closely with the process for compliance checks under self-assessment. 1.4 The measure will also introduce a new Targeted Anti-Avoidance Rule (TAAR), which 1 HMRC Consultation Document: Company Distributions, published 9 December _consultation_document 7029_.pdf 2

2 will apply to distributions in respect of share capital in a winding-up. This TAAR will treat the distribution from a winding up as if it were a distribution chargeable to income tax (rather than as a capital receipt), where certain conditions are met. The changes will have effect for transactions occurring on or after 6 April The consultation invites comments on what effect these changes might have, as well as inviting suggestions about how the problem might be addressed more widely. 1.6 Our response addresses both the amendments proposed in the draft legislation and the questions raised in HMRC s consultation document. 2 Executive summary 2.1 We can understand and support the Government tightening up the law in this area where active abuse is taking place. However, our overall concern is that the draft legislation in Finance Bill 2016 may go wider than intended, leading to increased uncertainty for business and difficulty in advising clients as to how HMRC or the courts would treat a transaction. 2.2 When the time does come to dispose of a business there will usually be, as in many areas of commerce, more than one way to achieve the objective without entering into convoluted arrangements. The owner may also have the choice of leaving cash behind or extracting it pre-sale. Just because one straightforward option gives rise to a higher tax charge than another should not mean that the former must be applied. Our concern is that HMRC seem to be heading towards the view that only the option that gives rise to the greatest tax liability is acceptable. 3 Question 1: Do you think that the ways in which a shareholder can receive value from a company in a form that is subject to CGT rather than income tax, as explored above, can lead to unfair outcomes? 3.1 If the Government thinks that the legislation in this area is not operating as Parliament intended, it is reasonable for it to consider amending it. We assume that this is what is meant by the words unfair outcomes. Where the government has identified what it considers to be unfair outcomes in a limited number of circumstances, as appears to be the case here, our view is that a targeted approach to dealing with them will lead to greater certainty and less complexity for taxpayers in general. 3.2 We would add that for many years there has to some extent been a choice of how to extract funds from a company and hence the treatment. Shareholders/directors have, for example, been able to choose whether to declare a dividend, often at short notice, and extract funds as income or leave funds in the business as working capital, perhaps enabling the business to grow at a faster rate, and extract them at the end of the business s life as capital. We do not see taking these choices as unfair outcomes. 3.3 This is the corollary to having a complex tax system which incentivises certain behaviour by having different tax rates for different types of transactions. P/tech/subsfinal/OMB/2016 2

3 4 Question 2: Do you think such issues will be exacerbated by the changes to dividends rules being proposed for April 2016? 4.1 It is difficult to know for certain how taxpayers will react to the changes to the dividend rules being introduced from April We are certainly hearing anecdotally that some dividends are being accelerated to before April This is understandable and is likely to be an objective of the Government as it will also bring forward any related tax liabilities. There will be a range of other reactions and economic psychology will presumably indicate that some taxpayers may re-arrange their affairs to take advantage of lower tax rates, but others may not. As ever, tax will be but one of the factors to consider when taking decisions although increasingly it is not necessarily the key consideration. 4.2 While we acknowledge that the setting of rates of taxes is not something on which the CIOT would normally comment, the Government should recognise that its ability to set rates is constrained by the inter-relationship between them, and that the problems identified in the consultation document (see paragraph 2.6) are largely of the making of a succession of governments in this case in particular the relationship between income tax rates (45%, as those likely to be able to influence corporate decisions at this level are probably 45% taxpayers), dividend income tax rates (38.1%), corporation tax rates (20% coming down to 18%) and CGT rates (effectively 28%). There is a tension between these rates which, if stretched too far, snaps and can lead to avoidance behaviour. The decrease in the corporation tax rate to 18% and the increase in the dividend rate to 38.1% may stretch this beyond the snapping point for some taxpayers On the other hand, many taxpayers may take the approach of accepting the increase in the dividend tax rate and are unlikely to reduce the frequency of extracting dividends from their companies. 4.4 Paragraph 3.1 seems to suppose that individuals do not require any return on capital, during the life of a company. Experience suggests many cases where dividends are drawn to provide an income throughout the life of a company. 4.5 In our experience, deliberately accumulating funds in a company in excess of the commercial needs of the business either before a sale to a third party (paragraph 3.6) or before a liquidation (paragraph 3.10) ( Moneyboxing ) is relatively rare and certainly not the norm. In any case, it is difficult to determine what is excessive, given the different cash needs of different businesses. 4.6 The consultation also gives insufficient weight to the way in which many companies have simply had to hold onto cash during the recession because banks were not lending to them. In our view, it is more likely that cash retention will occur for genuine commercial reasons so allowing cash to accumulate in a company should not be seen as actively talking steps to turn income into capital, more to ensure a business can ride another economic storm. 4.7 Paragraph 3.6 of the consultation document ignores the fact that, commercially, a third party buyer will not generally want to pay money in order to buy a company with surplus funds. 3 However, note that for a basic rate tax payer, CGT rates are higher than income tax rates for dividends (even after the increase in dividend tax rates in April 2016). P/tech/subsfinal/OMB/2016 3

4 4.8 We recognise that the example in paragraph 3.9, while extreme, is trying to explain a point but it is unhelpfully simplistic. It would have been more helpful if HMRC had provided an actual real-life example of what HMRC see as common examples of Phoenixism cases, which they find objectionable. 4.9 We accept that Phoenixism, if it is continuing, is a problem, although we had thought that the most offensive type of planning in this area was already caught by the transactions in securities legislation The consultation does not recognise that special purpose companies (SPV) (paragraph 3.10) are very often used for the good commercial reason of containing risk, for example, to carry out particular property developments, which have different risk profiles, different investors and different reward horizons. These are driven by commercial risk rather than tax advantage considerations. Trying to counter SPVs is likely to be quite counter-productive as it threatens to disrupt genuine commercial decisions A concern, for example, is the effect these changes might have in the property sector where a separate company is used as an SPV for each major project, usually for commercial reasons to ring fence any liabilities. These situations require certainty of outcome upon a MVL to attract investors. Members working with the industry indicate that the proposed change would be disruptive at the very time when the UK is relying on this sector to deliver economic activity, employment and housing. Although a main purpose test should be adequate in most cases, ultimately it will depend on how HMRC interpret the test Both capital reductions and MVLs are widely used in reconstructions and demergers. These are valuable techniques to reconfigure groups of companies and to demerge trading and other activities where statutory demergers are unavailable. Are these to be protected under any further legislation? 4.13 We are pleased to note that the government would like to retain the purchase of own share (POOS) rules. We agree that they are a very useful mechanism by which a shareholder in an unquoted company can reduce their shareholding. It is commonly used when shareholders are keen for commercial or family reasons for another shareholder to relinquish their shares, without the bringing in another party. In our view, the rules are already tightly drawn and operate satisfactorily, but if HMRC have concerns that they might be exploited in the future, we trust they will consult widely (and in accordance with the consultation process) on any proposed changes before introducing them. 5 Question 3: Do you agree that changes to the Transaction in Securities rules as proposed will be effective in terms of preventing the conversion of income to capital? 5.1 Yes. 5.2 Since clause 16 (3) makes it clear that the transactions in securities legislation will include a distribution in respect for securities in a winding up we wonder whether it is necessary to introduce a TAAR as well. P/tech/subsfinal/OMB/2016 4

5 6 Question 4: Do you think these changes will have any unwanted consequences not identified? How might these be mitigated? 6.1 We have already written to HMRC 4 to request clarification on clause 16(10) as it will affect transactions that receive clearance before 6 April 2016 but are not finalised until after that date, and received a useful response. 6.2 It would be helpful if HMRC could clarify the extent to which a section 682 clearance for a liquidation distribution will, going forward, provide comfort that the new rules in section 396B do not apply. The new rules are not part of section 682 and so are not strictly covered by a section 682 clearance. We understand that HMRC have not proposed a clearance system for section 396B, but this could leave anyone receiving clearance under section 682 on a winding up in a state of uncertainty. 6.3 The alternative would be to do both a statutory clearance under section 682 and a non-statutory clearance regarding the new rules. It would however be in everyone s interests to try and deal with this through the formal section 682 process to avoid duplication of clearances. Our suggestion therefore is that the TAAR is added into the transactions in securities clearance procedure. We would add that for many transactions a transactions in securities clearance will be sought in any event, so the extra work to include the TAAR in the clearance procedure will be quite small. We would also point out that transactions are often not done where there is the potential for a significant tax charge, so obtaining clearance is important. 6.4 With regard to repayments of share capital, we do not believe that there is any need for change in this area. 6.5 Some members report that difficulties in obtaining clearances from HMRC under section 701 ITA 2007 (in situations where they consider that clearance would previously have been given) are already being experienced. Is HMRC changing its approach in advance of the new legislation? 7 Question 5: Do you agree that the introduction of this new TAAR will be effective in terms of preventing the behaviour outlined in this section, and are there any better alternatives? 7.1 A concern is that the TAAR is being introduced to tackle only a small number of advisers and taxpayers who HMRC say are exploiting the current rules in limited specific circumstances (paragraphs 4.14 and 4.15). Despite being labelled as a targeted rule, the risk with such anti-avoidance legislation is that it encompasses a very wide range of commercial situations. Inevitably it will lead to complexity in the tax code and commercial uncertainty for all taxpayers over what will be acceptable to HMRC and what will not, with a potentially large number of genuine commercial transactions getting caught in the crossfire. 7.2 Clause 18, which is introducing the new TAAR, does not contain a clearance procedure, nor does it permit HMRC to issue a counteraction notice. It will be selfassessed by the taxpayer, making it crucial that taxpayers fully understand how 4 Letter to HMRC from CIOT dated 20 January %20-%20Transaction%20in%20securites%20-%20company%20distributions%20- %20CIOT%20comments.pdf?download=1 P/tech/subsfinal/OMB/2016 5

6 HMRC will interpret Conditions B and C in new section 396B. 7.3 There is a risk that as drafted it will be seen as another case of taxed by legislation, untaxed by guidance. 7.4 Given that liquidations are seen as the main problem area by HMRC, perhaps a better solution to the perceived problem might be simply to introduce a supplementary rate of CGT on liquidations (there is a model in TCGA 1992 section 91). This could be done, we would think, relatively easily without having to introduce anti-avoidance legislation. Trying to cater for those exceptions is likely to lead to yet more complexity in the tax code, whereas a simple supplementary rate of CGT would sort out most of the problems. Members often find that businesses are more concerned about certainty, than the specific rate of tax, so that they can plan accordingly. 8 Question 6: Do you think that the TAAR will have any unwanted consequences not identified? How might these be mitigated? 8.1 The conditions referred to in draft clause 18, which will be contained in new ITTOIA 2005 section 396B, include Condition B, that: at any time within a period of two years beginning with the date on which the distribution is made - (a) the individual carries on a trade or activity which is the same as or similar to that carried on by the company, (b) the individual or a person connected with him or her is a participator in a company which (i) (ii) carries on such a trade or activity, or is connected with a company which carries on such a trade or activity, or (c) the individual is involved with the carrying of such a trade or activity by a person connected with the individual. 8.2 This is so wide that we can foresee it may have an impact on commercial decisions and will create unnecessary and disconcerting uncertainty. Perhaps a solution is that there should be a control test, or a de minimis type test, rather than a close company test here to try to target the test better. Much will depend upon how HMRC intend to interpret the condition, the main purpose test in Condition C and their interaction (section 396B(5)), so some clarification from HMRC will be essential. 8.3 We think that the inclusion of the word activity will also lead to uncertainty. We suggest it is removed as it is more likely to catch cases that we think are not the target than catch the target. Similarly, the word involved in section 396B(3)(c) is vague and potentially very wide. 8.4 Situations where we can foresee that Condition B might be satisfied include the following, most of which we do not think should be the target of the legislation: (i) A spouse subsequently holds shares in a quoted company that carries on the same sort of activity as the company in liquidation; (ii) An individual liquidates their company and retires but then takes on a small number of clients in retirement; (iii) An individual liquidates their company and retires but then is employed at a lower level in a connected person s business; (iv) If the company s activity was property investment, the individual or their P/tech/subsfinal/OMB/2016 6

7 (v) (vi) spouse continues to own a couple of buy-to-let properties in a personal capacity; The serial entrepreneur who genuinely invests in a number of unrelated EIS companies which happen to be close companies with similar trades, for instance Octopus, Triple Point, Downing etc all seem to offer EIS companies in the renewable energy field. Does this mean that when one of them is liquidated, all the others lose CGT treatment? Similarly, does this mean that on the liquidation of an investment company, the individual cannot invest (in anything) for the next 2 years? Surely this is not intended. 8.5 The individual might claim that it is reasonable to assume avoidance or reduction of income tax was not the main purpose or one of the main purposes of the winding up or arrangements including the winding-up (condition C), but that defence would not be available to any shareholder, no matter how small his interest in the company in liquidation, if the controlling shareholders chose to wind-up the company in preference to distributing its profits by way of dividend. 8.6 The result of this clause applying would be especially harsh where the shareholder s acquisition cost exceeds the amount originally subscribed for his shares. Someone who has inherited their shares and then liquidates the company might realise little more than their probate value so have no significant capital gain, and yet be subject to income tax on almost all of the distribution, if the amount originally subscribed perhaps by a grandparent was trivial. This is a fairly common situation. The extra amount subject to income tax will equal an allowable loss for capital gains tax purposes. This loss, even if usable, will generally be worth less than the income tax liability. 8.7 New section 396B(6)(b) introduces an exclusion for distributions that are part of a liquidation demerger - where a distribution is to an individual and is a distribution of irredeemable shares in a company which is an effective 51% subsidiary of the company which is wound up. We understand that HMRC are reviewing whether there is any need for the 51% subsidiary test. 9 Question 7: Do you think that the government should consider making further changes to address the conversion of income to capital? If so what other solutions do you think the government should consider? 9.1 No, we think that the changes currently proposed should be given time to bed in before any further changes are considered. 9.2 We would strongly resist the re-introduction of close company apportionment (paragraph 5.2 of the consultation document), which we consider would bring great uncertainty to business and a significant burden to HMRC in monitoring this. 10 Question 8: Are there any particular areas of the wider distributions regime that cause difficulties or complexities? If so, which areas? 10.1 No comments. 11 Question 9: Do you believe there is any value in extending this consultation to P/tech/subsfinal/OMB/2016 7

8 consider the regime as a whole, after the changes proposed for April 2016? 11.1 We do not see the need for another review of the distributions legislation after the changes proposed for April A review of the legislation on demergers generally would be welcome. Exempt distribution demergers are subject to many restrictions, some of which are completely arbitrary and some of which relate to repealed rules and so are no longer relevant, when every demerger can alternatively be carried out by liquidation or by reduction of capital with no loss of tax. This results in increased costs and complexity. A review of this whole area is overdue More generally, it would be useful if HMRC and Companies House worked together to develop UK company law and tax law to allow UK registered protected-cell companies (PCCs), also known as divided cell companies, where different liabilities could be limited within the structure of a single company. Many offshore jurisdictions, such as Guernsey have allowed this for a number of years. There is a tax definition of a divided cell company in Finance Act 2003 section 194, which is expanded in the TCGA 1992 section 14F, introduced in 2015 for non-resident CGT charge, which could be used to prevent abuse around the close company rules. 12 Acknowledgement of submission 12.1 We would be grateful if you could acknowledge safe receipt of this submission, and ensure that the Chartered Institute of Taxation is included in the List of Respondents when any outcome of the consultation is published. 13 The Chartered Institute of Taxation 13.1 The Chartered Institute of Taxation (CIOT) is the leading professional body in the United Kingdom concerned solely with taxation. The CIOT is an educational charity, promoting education and study of the administration and practice of taxation. One of our key aims is to work for a better, more efficient, tax system for all affected by it taxpayers, their advisers and the authorities. The CIOT s work covers all aspects of taxation, including direct and indirect taxes and duties. Through our Low Incomes Tax Reform Group (LITRG), the CIOT has a particular focus on improving the tax system, including tax credits and benefits, for the unrepresented taxpayer. The CIOT draws on our members experience in private practice, commerce and industry, government and academia to improve tax administration and propose and explain how tax policy objectives can most effectively be achieved. We also link to, and draw on, similar leading professional tax bodies in other countries. The CIOT s comments and recommendations on tax issues are made in line with our charitable objectives: we are politically neutral in our work. The CIOT s 17,500 members have the practising title of Chartered Tax Adviser and the designatory letters CTA, to represent the leading tax qualification. The Chartered Institute of Taxation 5 February 2016 P/tech/subsfinal/OMB/2016 8

Company distributions

Company distributions Response to the HMRC consultation document of 9 December 2015 3 February 2016 1. Introduction 2 1.1 Overarching objectives 2 2. Executive summary 2 3. General comments 2 4. Responses