HMRC have long been concerned that tax payers have been ‘abusing’ members’ voluntary liquidations as a means of accessing reserves (which would otherwise be payable as dividends). For example property developers have often run development projects through separate companies. In these kinds of structures the companies would generally incur 20% tax on profits (so £100 of profit would be reduced to £80) and then the shareholders would suffer 10% tax at Entrepreneurs’ Relief rates to extract the remaining funds (receiving £72 of the remaining £80). In this way property developers would face an overall tax rate of 28% on development profits, comparing very favourably to 45% additional rate income tax.
New rules will be introduced for distributions from a liquidation which take place after 5 April 2016. These will have the effect of deeming any liquidation distributions to be taxable as dividends rather than capital receipts, subject to certain exceptions. In broad terms these rules will apply if the recipient shareholder carries on a similar trade or activity (whether personally or through a company) within two years of the distribution.
The most obvious implication of this is that shareholders should be considering racing through liquidations before 6 April 2016 where viable. After this date the tax on the final distribution could increase by as much as 29.1% (which is the difference between 10% and top rate dividend tax). After 5 April 2016 there may be scope to argue that the rules should not apply due to differences in the trade or activity being carried out after the liquidation – but defences here will often be limited.
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