Can we still extract reserves at 10%?

Background

HMRC continue their battle against taxpayers who seek to extract funds from their companies at low 10% Entrepreneurs’ Relief rates rather than dividend rates of up to 38.1%. Finance Bill 2016 supposedly quashed many opportunities for ‘receiving income as capital’. For example capital reductions were brought squarely within the transactions in securities legislation rules (TISL) and these rules were broadened in many other ways too.

In a nutshell TISL allows HMRC to come along and tax capital transactions as income where they feel that it is in some way ‘offensive’ for the taxpayer to be taxed at capital gains tax rates on what is in substance income. The classic case involved the Cleary Sisters who owned two companies and sold one company to the other, using the reserves of the purchasing company to pay the consideration. HMRC successfully applied TISL to re-establish a ‘fair’ position whereby the sisters were taxed as if they had received a dividend from the purchasing company.

The TISL rules were complicated and had many shortcomings which allowed opportunities to exist where the rules could not apply. These have now generally been tightened up and the rules will apply in more situations and so these opportunities no longer exist. Well…..it is perhaps not quite as simple as this…..

 

Quirk in TISL rules

Most tax legislation works on a self-assessment basis – that is the taxpayer has to apply the legislation in the correct way to pay his or her tax and limit the scope for penalties. TISL does not work in this way but rather gives HMRC 6 years from the end of a tax year to enquire into a transaction that they think will fall within TISL. If HMRC is successful then the taxpayer will have to pay the difference between capital gains tax and income tax along with any late payment interest.

In fact there is no mechanism for a tax payer to correctly self-assess him or herself to TISL. Even a Cleary type transaction (above) would have to be reported as a capital gain along with Entrepreneurs’ Relief if appropriate. It is still up to HMRC to make the adjustment.

 

Implications

It is therefore possible that some taxpayers will be happy to proceed with transactions in the knowledge that they fall squarely within TISL. Although they will bear the risk of a HMRC counteraction within 6 years of the end of the tax year they can take comfort in the fact that they are fully complying with the rules of self-assessment. If HMRC fail to get their act together then the taxpayer will have extracted funds at very favourable rates. It remains puzzling as to why this quirk was not ironed out as part of the recent revamp!

 

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