“Phoenixing” describes the practice of setting up a company for a specific contract and then closing the company down once the contract has ended.
In this way, directors are able to claim Entrepreneurs’ Relief on business assets above the Capital Gains Tax (CGT) Allowance, which is currently £11,100 and increasing to £11,300 in 2017/2018. The process is repeated when directors win a new contract and form another company. In certain circumstances, where the directors are carrying out the same trade or profession and/or were simply between contracts, it becomes apparent that the initial company should never have been closed.
However, this poor practice does go on, and some directors are unaware of the negative light in which this is cast by UK Company Law or by HMRC.
Phoenixing and Lower Tax Rates
HMRC is challenging a number of cases where directors are claiming Entrepreneurs’ Relief on phoenix companies to taken advantage of CGT rates on the liquidation of the company. These rates can be as low as 10%, which is much lower than income tax rates.
Phoenixing is a red flag to HMRC, and the authority has ruled under a specific set of anti-avoidance rules announced in the Finance Act 2016 that it will be impossible to get a lower tax rate using these methods. Although directors will still be able to open and close a series of companies, they can no longer gain a tax advantage whilst carrying out the same profession.
The Finance Act and TAAR
The Targeted Anti-Avoidance Rules or TAAR have been put in place to make sure that anyone closing a limited company and then opening a new one with the same trade will have to seek non-statutory clearance with HMRC. In this way, the taxman will be able to check whether there are genuine reasons for winding up of the company and to make sure that the sole purpose or one of the main purposes isn’t to phoenix the company.
To combat phoenixing, a distribution from a winding-up will be treated as if it were income, where the following four conditions are met:
- The company must be a close company or in other words, a limited company owned by five participators/ shareholders or less
- The individual must own at least 5% of the company
- On receiving a distribution, the individual continues to be involved directly or indirectly with the same or similar trade or activity as the wound up company within two years of the winding-up. This also applies if he or she is working for a spouse or a connected party
- The circumstances show that it’s reasonable to assume that the main purpose or one of the main purposes of the winding-up is to obtain a tax advantage.
Some directors who get involved in bad practices, such as phoenixing do so as a result of poor advice. If you would like to find out more about TAAR or to discuss HMRC’s approach to phoenixing and the consequences of this bad practice, please call 08000 746 757 or email [email protected] for free and confidential advice from one of our professional advisers.