The first quarter of 2016 saw a spike in the number of members’ voluntary liquidations as many entrepreneurs - property developers prominent among them - moved to pre-empt incoming changes to the taxation treatment of winding up a company that were introduced in the 2016 Finance Bill.
As a result, HMRC has now shone the spotlight on ‘phoenixing’: the process of extracting profits from a company without payment of a revenue dividend, by way of serial liquidation, and then establishing a new ‘phoenix’ company in the same trade within two years.
While HMRC is seeking to curb this method of avoiding tax, the focus on this area will have a disproportionate effect on those for whom winding up companies to extract profits before setting up in the same space again is a legitimate part of their business process.
For the property industry, this is part and parcel of finishing a development, and those using this process for genuine reasons could now find themselves coming under scrutiny from the Inland Revenue.
What then must property companies do to avoid wrongly showing up on HMRC’s radar? Phoenixing adopts a ‘capture and discard’ approach. The ‘capture conditions’ mean that any distribution in liquidation by a private company is caught where the recipient shareholder, at any time in the following two years, carries on any trade or other activity similar to that previously carried on by the company.
The discard condition requires the application of a ‘main purpose test’: it must be reasonable to assume that the main purpose of the liquidation was not to avoid income tax.
Many single property or single-site developments are conducted through SPVs, which are generally liquidated at the conclusion of the development, as much for liability protection reasons as for tax.
Should a similar development be commenced by the shareholders within two years, then on the face of it the previous capital distribution must now be treated as a revenue dividend, dependent upon the ‘main purpose’ found.
Many such ventures may also be conducted as joint ventures, with different parties coming together as opportunity presents. Each participant may have a different record of participation in such ventures and will have a capital or revenue distribution dependent upon that participation. Again the ‘main purpose’ of the liquidation will affect the tax treatment.
HMRC has not yet given any guidance on phoenixing, and we are likely to see uncertainty in many liquidations until they do. Developers should therefore fully document the commercial reasons for any winding up and ensure that adequate disclosure is made when reporting the resulting gain. In short, tread carefully and ensure you have the right reporting in place to avoid getting burnt.
Neil Simpson is a tax partner at haysmacintyre